RBS closer to transition than dividends

No champagne

RBS’s first headline profits this decade and a hint that dividends are “closer” have not been enough to trigger shareholder applause. The outstanding mortgage-backed securities case is too much of a worry. Lack of a clear update on the Department of Justice litigation means pay-outs are unlikely to start in 2018—dividends can’t be paid before the government has sold its 71% stake.

Worst-case not expected

But Friday’s share price reaction doesn’t assume the worst-case scenario. The loss of about $2.1bn in market value implies RBS is expected to pony up more than the $4.4bn it had set aside by the end of last year. But the total would still be around half the most pessimistic charge expected. It would be painful, but absorbable, given RBS’s key capital buffer had strengthened to 15.9% by the end of the year, the highest ratio amongst UK rivals. The scenario does of course require the DoJ to stick to its pattern of mandating settlements below the highest possible; usually contingent on humble co-operation (hello, Barclays). But the scenario is a plausible base case. And it would still allow RBS a tentative path to growth and shareholder returns.

Nearer to “sustainable”

That’s after annual total income comfortably topped quarterly forecasts and operating profit excluding charges rose 31% to £4.6bn in 2017. What’s more, adjusted Return on Tangible Equity – possible shareholder returns once the ‘bad bank’ is sold and excluding one-offs – was 8.8%. Assuming RBS’s end state is in sight, the figure closes the gap to the 12% target at which the group says “sustainable returns” would be possible.

Innovation costs

Slightly blurred cost goals are less welcome. RBS still targets a less than 50% cost/income ratio by 2020, but an absolute cost target has been scrapped as obligations remain volatile and investments demanding. For instance, a depreciation charge pushed costs to 79% of income over the year from 67.5% in Q3. The group also said investments over two years would be £1.5bn higher than forecast partly due to increasing “innovation spend”. Some investors have grumbled about increased spending on Friday so these are likely another reason for the negative share reaction.

A better Good Bank

Indeed, with RBS shares edging closer to book value after outpacing rivals in 2017, the stock is beginning to price a perfect transition. That remains unlikely. With real returns on equity of just 2.2% in 2017 a UK downturn could call all promising bets off. Nevertheless, RBS is still exponentially sounder than looked feasible a few years ago.

Thoughts on RBS’s share price chart

Make no mistake; Friday’s drop has done damage. RBS has seen inarguable support from a clean rising trend line since post-Brexit vote lows. Friday’s trend break represents the first time that support has become questionable. It’s a warning from investors that further delays before a return to dividend payments will be tolerated less. But the support break need not be terminal. The shares have returned to a region won in September after a five-month struggle. The stock is unlikely to drop like a stone through it. Plus confirmed support since the autumn lies near 265p. Buyers would be wise to wait till the stock approaches it. A bounce there is likely, but collapsing sentiment—see Relative Strength Index sub-chart—may have further to run. Getting back above trend may take longer than a few sessions, but would confirm the bull still prevails.