RBS looks to steer a course through troubled waters

RBS announces full-year earnings on 26 February, having seen its share price rally by a third since its nadir in April 2014.

An RBS logo
Source: Bloomberg

RBS is forecast to post adjusted earnings per share of 35p, on sales of £18.8 billion. Earnings have remained steady for the group in recent years, but analyst coverage is still cautious, with four buys, 19 holds and ten sells according to Bloomberg data.

UK banks face a number of problems as they head into 2015 and their next financial year. The key element is the question of interest rates, both at home and abroad. Both the Bank of England and the Federal Reserve appear to be much closer to raising rates than their counterparts at the European Central Bank and others, but that could quickly change should the economic outlook worsen. A rise in interest rates would see fixed income revenue increase, but this may not come to pass if central banks hold fire on rate rises.

The main UK problem is the general election. Political risk is on the table for the months to come, if the electorate fails to make a definitive choice and a hung parliament emerges in May. That will make economic planning more difficult, given that the government that emerges may not be able to construct a clear policy.

We should also assume that litigation costs for the sector will continue to rise. PPI provisions have been a tedious feature over the past few years, and other claims will continue to come to light, putting a dampener on earnings.

For RBS, the sale of its US citizens division has been beneficial for its capital requirements, providing additional funds as a buffer in case of an economic downturn. However, more funds will need to be set aside for FX and US mortgage claims. RBS is involved in cases relating to issuance of more than $67 billion in mortgage-backed securities, according to JPMorgan.

When looking at RBS’ results, the performance of the Capital Markets division will be vital. RBS is highly leveraged to the fixed income area of the market, and thus earnings will be significantly affected depending on whether the performance of this part of the business is good or bad. In addition, the bank is likely to see an improvement in its Irish business, as property prices rise, but as I have already noted, the litigation element could undo much of the good work across the rest of the bank.

RBS has a lower return on equity (RoE) than the global sector average, at 5.5% versus 8.4%. HSBC and Standard Chartered have both seen higher RoE, indicating that both of these banks have enjoyed higher rates of growth. Forecasts suggest no real improvement in RBS’ performance, with RoE falling to just 2.4% for the next two years. RBS also falls down on its dividend yield – it does not have a payout, as it is still largely owned by the UK government. Thus for income hunters, the bank offers little attraction. Lloyds is still in discussions about returning to dividend payments, but RBS is still a long distance from reaching this point, if it ever does.

RBS has seen its shares rally since hitting a low below 300p in the first half of 2014. Since then, the shares have broadly adhered to an ascending price channel, moving back above the 200-DMA in August of last year. 2015 has been volatile so far, but as in December, the 360p mark has provided strong support. The shares have moved back inside the rising channel during February, and while February has seen resistance at the 390p level, a break above here would first target 395p and then the December high at 400p, the highest level since July 2011.

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