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RBS – I Can See Clearly Now: Jefferies

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The Royal Bank of Scotland will move from a restructuring story centered on shedding non-strategic businesses and unwinding legacy assets to a core earnings story over the next 18 months, according to research firm Jefferies.

Joseph Dickerson and team at Jefferies in their February 9, 2015 research note titled: “I Can See Clearly Now” have revised their price target for RBS up to 530 p from 500 p.

RBS group’s earnings visibility to improve

According to the Jefferies analysts, over the next 18 months, RBS will move from a restructuring story centered on shedding non-strategic businesses (such as Citizens) and unwinding legacy assets (such as Irish commercial real estate) to a core earnings story.

The analysts highlight that RBS group’s earnings visibility would massively improve from mid-2016 onward. The following captures RBS’ three straightforward business units:

As can be seen from the following table, the Jefferies analysts believe by 2017, RBS’ three core UK & Ireland focuses businesses viz.: Personal & Business Banking, Commercial & Private, Corporate & Institutional will generate 100% of group PBT:

100pc group PBT from 3 units RBS

The analysts also anticipate that by 2017, these three core businesses will generate a 14% return on allocated tangible capital. As set forth in the following table, with an implied ROTE of just 5%, the Corporate and Institutional unit represents a meaningful 700 bps drag to group ROTE.

Core to generate 14pc ROTE RBS

However, they also suspect management will seek to restructure the business further so as to generate a more respectable return. The analysts point out that any such restructuring would be a bullish signal for return improvement and trigger likely multiple enhancement.

Positive catalysts galore for RBS

Dickerson et al. note investors have a variety of positive catalysts to look forward to in 2015. For instance, further floatation of Citizens Financial in the spring and summer would take RBS’ stake in the bank below the control threshold. The analysts anticipate the deconsolidation benefit is 260 bps of CET1. Other positive catalysts include: floatation of Williams & Glynn and start of the sell down of HTM’s stake in the bank after the general election in May. The Jefferies analysts also point out that run off of the bad bank will be effectively complete by end of year, which will generate a £565 million net profit over its life compared to an expected loss of £2.5bn – £3.0 billion at inception:

RBS' RCR forecast

The Jefferies analysts point out that another important source of optionality is RBS’ £143 billion liquidity portfolio. The analysts note as at Q3 14, the liquidity portfolio represented 4.6x the bank’s short-term wholesale funding position, as against an estimated need to operate at 1.5x – 2.0x over the medium term. Thus, the analysts estimate RBS has a theoretical excess liquidity pool of £80 billion – £97 billion that could be re-deployed into lending. They believe in practice around £20 billion – £30 billion of such excess could be redeployed into lending activities over the next three years. As depicted in the following tables, if liquidity was deployed into retail and commercial banking units, which generated a NIM of 328 bps at Q3 14, the uplift to net interest income would be 7 to 11%.

NIM by core business RBS

Enthused about the outlook for the Royal Bank of Scotland, the Jefferies analysts have assigned a “Buy” rating and revised the price target up by 6%.

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