Morningstar | High Liquidity Requirement and Litigation Provisions Hurt 2Q Profits for RBS; DoJ Settlement Reached
The release of uncertainty around the U.S. Department of Justice settlement case related to missold residential mortgage-backed securities and a planned interim dividend of GBX 2 per share outweighed the Royal Bank of Scotland's uninspiring operational performance in the second quarter of 2018. The civil settlement reached in principle with the DoJ requires RBS to pay GBP 3.7 billion, which falls into our expected range of GBP 3 billion-GBP 4 billion. Additionally, RBS is looking to increase the dividend payout ratio to about 40% over time, while considering further capital distributions alongside regular dividends. However, distributions are subject to capital stress tests and the winding-down of provisions and settlements over the coming quarters. The commencement of the GBX 2 per share interim dividend is expected with the finalisation of the DoJ settlement, which we anticipate occurring in second-half 2018. As such, we believe RBS is not over the hill just yet, although progress is looking promising. We maintain our GBX 290 per share fair value estimate and our no-moat rating. We prefer Lloyds as a U.K.-centric bank.Operations have been negatively affected by issues other than charges related to the DoJ settlement. The net interest margin dropped to 2.01% in the quarter from 2.13% last year, primarily owing to higher liquidity needs. RBS’ high liquidity ratio of 167% stems from management's caution in buffering for the DoJ settlement, higher pension funding requirements of GBP 2 billion, uncertainty around Brexit, and provisions for payment protection insurance, or PPI, claims. While these issues differ in expected duration, we believe that the liquidity ratio will improve through the year, releasing some pressure on the net interest margin. Attributable profits of GBP 96 million for the quarter (GBP 680 million last year) have been underwhelming and are largely the result of lower income paired with higher litigation costs.
RBS' capital position remains good. Its common equity Tier 1 ratio stands at 16.1%, including pension contributions, the DoJ settlement, and the planned interim dividend.
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