Today I am looking at why I believe Royal Bank of Scotland (LSE: RBS) (NYSE: RBS.US) remains too risky a pick for stock selectors.
Trouble at the core
Royal Bank of Scotland’s August interims revealed somewhat of a mixed bag. Group operating profit nudged 5% higher in January-June to £1.68bn as the company’s transformation plan delivered. The main driver behind the result was a 42% reduction in non-core operating losses, to £786m, as impairment losses fell and expenses dropped.
However, core operating profit collapsed 17% in the first half to £2.46bn, mainly as revenues in its key Markets arm plummeted. Revenues at the firm’s UK Retail and UK Corporate divisions also continue to struggle due to insipid loan growth and poor margins. Royal Bank of Scotland still has much work to do before a marked recovery in these areas can be expected.
Nationalisation question still looms large
Another lingering issue affecting Royal Bank of Scotland is the timing of the government’s divestment of its 84% share in the bank. Indeed, business secretary Vince Cable noted last month that a full return of the bank to private ownership before 2018 remains ‘pretty unrealistic.‘
In the meantime, the prospect of any sort of appetising dividend is likely to remain well off the agenda for some time. Broker Investec does not expect the first investor payout to materialise until 2015 at the earliest.
Fresh legal battle on the horizon?
Banks continue to be in the firing line from the Financial Conduct Authority (FCA), the sector having been dragged through the mud due to the mis-selling of payment protection insurance (PPI). The latest crisis threatening to engulf the industry relates to misconduct over the sale of interest rate hedging products (IRHPs).
An FCA report published earlier this month revealed that just £500,000 had been paid by banks over the mis-selling of swaps as of August 10, but that this sum is set to leap higher as negotiations hot up. And Royal Bank of Scotland is the most exposed of all the UK banks in terms of pending cases, with a whopping 10,528 outstanding — this is more than three times that of second-placed Barclays.
The scale of settled claims so far has been modest, and banks have set aside cumulative provisions of £3bn for case settlement, illustrating the scale of the storm yet to come. Royal Bank of Scotland has set aside just £750m in provisions, and Investec notes that the bank “appears the most likely bank to require material additional provisions for the IRHP issue” should the financial fallout from the redress process balloon.