The government’s recent decision to allow Royal Bank of Scotland Group (LSE: RBS) (NYSE: RBS.US) to continue using an internal bad bank to handle its bad debts gathered lots of headlines, but just how bad are RBS’s debt problems?
RBS’s third-quarter update advised that the shift of assets into its new internal bad bank is likely to result in “a significant increase in impairments in Q4 2013”, resulting in a “substantial loss for the full year”. RBS has already reported impairments of £3.3bn this year, but these comments suggest to me that impairments could rise above last year’s total of £5.3bn.
Rising arrears
Bad debts start when borrowers get into arrears, and according to RBS’s third-quarter update, 9.4% of the bank’s loans were more than 90 days in arrears at the end of September, up from 9.1% at the end of 2012.
Although the size of RBS’s overall loan book has fallen this year, the fact that the proportion of loans in arrears has risen suggests that the bank is unable to sell the worst loans, or that additional loans are starting to fall into arrears.
A £40bn question mark
RBS’s 9.4% rate of arrears means that £40bn of its loans are currently non-performing.
RBS has made provisions of £21bn against these loans, but so far this year, it has only written off £3.1bn, leaving a further £18bn in provisions that could yet be impaired and written off.
What about the good loans?
RBS has £41bn of non-core (bad) loans, of which a staggering 47.7% are in arrears. These will soon be consigned to RBS’s new internal bad bank, but unfortunately the problems don’t end there.
In its core (good) loan portfolio, RBS has £387bn of loans, of which 5.3% are currently in arrears. The majority of these are property related, and arrears on RBS’s commercial property loans have actually increased this year, rising from 10.7% to 12.7%, while personal loan and mortgage arrear rates have remained largely unchanged.
Is RBS a buy?
At the end of September, RBS reported a tangible net asset value per share of 431p. At first glance, this makes its shares good value, at today’s price of 331p, but investors need to consider the likelihood of further bad debts arising over the next few years.
I believe that valuing RBS’s loan book accurately at the moment is almost impossible, but further losses seem almost certain.Â