The Royal Bank of Scotland Group plc

FINANCIAL INSTITUTIONS
The Royal Bank of Scotland Group plc
ISSUER IN-DEPTH
11 January 2016
Substantial Restructuring Progress Underpins Our Positive
Outlook
Summary
RATINGS
The Royal Bank of Scotland Group plc
LT Senior Unsecured
Ba1
Subordinate
Ba2
Junior Subordinate
Short Term
Outlook
Ba3
Non-Prime
Positive
Contacts
Andrea Usai
4420-7772-1058
VP-Sr Credit Officer
[email protected]
Alessandro Roccati
44-20-7772-1603
Senior Vice President
[email protected]
Daniel Forssen
44-20-7772-1553
Associate Analyst
[email protected]
Laurie Mayers
44-20-7772-5582
Associate Managing
Director
[email protected]
Robert Young
MD-Financial
Institutions
[email protected]
212-553-4122
The substantial progress management has made in the complex restructuring of The Royal Bank
of Scotland Group plc (RBS, LT senior unsecured Ba1 positive) has improved the group’s credit
fundamentals, leading us to assign a positive ratings outlook on 14 December 2015. At the same
time, we have affirmed the baseline credit assessment (BCA) of the main operating entity, The
Royal Bank of Scotland plc (LT deposits A3 positive, LT senior unsecured A3 positive, BCA: ba1)
and all of the group’s ratings at current levels. This reflects our expectation that RBS will continue
to pursue measures to improve profitability, reduce still-sizeable capital markets operations, and
lower asset risk further.
RBS’s regulatory capitalisation has continued to increase on the back of heavy
deleveraging and disposals, though capital ratios will remain volatile over the next
12-18 months. Deleveraging has raised the group’s Common Equity Tier 1 (CET1) ratio by 150
basis points to 12.7% in the first nine months of 2015, and the leverage ratio improved by
80 basis points to 5% during this time period also due to the recent Additional Tier 1 (AT1)
issuance. The group has also completed the sale of its US subsidiary Citizens,1 which will further
increase its CET1 ratio (on a pro-forma basis) by around 350 basis points and the leverage ratio
by around 60 basis points. This provides RBS with an increasingly high capital cushion to absorb
losses from pending litigations and high restructuring costs, which will cause ongoing volatility
in the group’s capital ratios.
RBS will continue to be loss making in the coming quarters. The group’s profitability will
continue to suffer as large restructuring, conduct and litigation charges are incurred. In addition,
we believe that the ongoing reshaping of the group is disrupting the operational performance
of some of its core operations, particularly Corporate & Institutional Banking (CIB).
Asset risk is declining as further deleveraging is achieved, lowering the group's
downside risks. Credit metrics have continued to improve owing to the disposal of poorquality assets, lower exposures to markets outside the UK and the supportive operating
environment in the UK (Aa1 stable) and Ireland (Baa1 positive). This has led to a large drop in
non-performing loans (NPL) over gross loans.2 to 4.5% at the end of September 2015 from
6.8% at the end of 2014. RBS’s remaining asset risk largely stems from concentrations in the
UK and Irish real estate sectors and still large, albeit decreasing, capital markets operations.
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Already sound funding and liquidity continue to improve. Funding and liquidity, credit strengths for RBS, have continued to improve
as a result of the group’s ongoing deleveraging. The group is gradually reducing its wholesale funding stock, lessening its reliance on
confidence-sensitive funding sources, and is increasing its pool of liquid assets versus liabilities.
Execution risk from the ongoing restructuring is declining.The restructuring of RBS’s core retail and commercial banking operations
and its CIB business is ongoing, but the scope for operational losses that could impair the group’s strong franchise will narrow as the
plan proceeds.
De-risking and issuance of contingency capital have strengthened the group’s solvency
Strong execution in de-risking and restructuring, along with favourable market conditions, have enabled RBS to advance its overall strategy
much more quickly than planned. The group’s regulatory capitalisation has strengthened rapidly since management announced a number
of capital-accretive actions at the end of 2013. Deleveraging achieved in the first nine months of 2015 led to an improvement in the CET1
ratio to 12.7% (Exhibit 1). Moreover, the deconsolidation of Citizens, following the completion of the sale announced on 30 October
2015, will boost the regulatory capital ratio by another 350 basis points (pro-forma basis).
The group’s increased capital cushion is positive for RBS bondholders because it increases the firm’s capacity to absorb unexpected losses,
large litigation charges, as well as costs resulting from regulatory reviews and restructuring, without constraining its ability to lend in
the UK. RBS is targeting a CET1 of above 13% by the end of 2016, after accounting for these large charges and the planned repayment
of the Dividend Access Share.3 Although the timing and magnitude of these large costs is uncertain, we expect the group to be able to
meet this target.
Exhibit 1
Capital-Accretive Actions Are Leading to Higher Regulatory Capitalisation
RBS’s reported and targeted CET1 ratio (end-point)
Source: RBS’s quarterly Interim Management Statements.
Heavy de-risking has also lowered leverage, as indicated by an 80-basis-point increase in the group’s Basel 3 leverage ratio to 5% over the
first nine months of 2015 (Exhibit 2); this also benefitted from the £2 billion issuance of high-trigger Additional Tier 1 (AT1) last August.
The Citizens’ disposal has also generated a further (pro-forma) 60-basis-point improvement in the leverage ratio.
This publication does not announce a credit rating action. For any credit ratings referenced in this publication, please see the ratings tab on the issuer/entity page on
www.moodys.com for the most updated credit rating action information and rating history.
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The Royal Bank of Scotland Group plc: Substantial Restructuring Progress Underpins Our Positive Outlook
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Exhibit 2
The Leverage Ratio Is also Improving
RBS’s Basel 3 leverage ratio
Source: RBS’s quarterly Interim Management Statements.
RBS’s (pro-forma) CET1 ratio is currently the highest within the Global Investment Banks (GIBs) peer group at around 16.2% (Exhibit 3).
However, in our capital assessment we also take into account the expected volatility in capital ratios due to the future large restructuring,
conduct and litigation costs and the group’s constrained ability to raise additional external equity capital owing to its quasi-ownership
by the UK government (Aa1 stable), which has publicly stated it has low willingness to inject further capital into the firm.
Exhibit 3
RBS Currently Has The Highest Regulatory Capital Ratio Amongst Peers
Global Investment Banks: CET1 ratio (Fully-loaded Basel 3)
**Swiss capital regime
Source: Company reporting.
Profitability will remain subdued as the restructuring progresses
Substantial litigation charges, conduct-related costs and restructuring expenses have resulted in heavy losses for RBS over the past few
years, making it an outlier within its domestic peer group (Exhibit 4). We expect the group’s profitability to remain subdued over the next
12-18 months as it continues to absorb such costs. However, because RBS maintains a strong franchise in the UK, and has growing retail
and commercial banking market shares, we expect it to deliver more stable and predictable earnings once the restructuring is largely
completed.
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11 January 2016
The Royal Bank of Scotland Group plc: Substantial Restructuring Progress Underpins Our Positive Outlook
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Exhibit 4
Profitability Trails Peers on Account of Large Restructuring Costs
Large UK Banks: pre-provision income / average risk-weighted assets
Basel 3 data from 2013 (fully-loaded where available), Basel 2 prior to that.
Source: Moody's Banking Financial Metrics and Moody’s estimates.
The improved operating profits of the group’s core retail and commercial banking operations continue to be eroded by extraordinary
charges (Exhibit 5). In addition, the restructuring is disrupting the operational performance of the core CIB business, as evidenced by a
30% yearly decline in revenues to £1 billion in the first three quarters of 2015 compared with the same period last year.
Exhibit 5
Improving Core Operating Profits Eroded by Conduct, Litigation and Restructuring Charges
RBS: Operating profits versus charges by business line
Source: RBS's Annual Reports and Data Supplements.
In addition, RBS’s historical earnings volatility is the highest amongst its international peers (Exhibit 6) and is another negative driver of
our profitability assessment.
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The Royal Bank of Scotland Group plc: Substantial Restructuring Progress Underpins Our Positive Outlook
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Exhibit 6
RBS’s Earnings Volatility Is Highest in its Global Peer Group
Global Investment Banks: historical earnings volatility
Source: Moody’s calculations based on company annual and semi-annual reports.
As a result of the foregoing factors, our profitability assessment for RBS places the group lowest amongst its GIB peers (Exhibit 7), and
is one of the main constraints on its standalone credit profile.
Exhibit 7
Negative Profit & Loss Bottom Line Drags Down Profitability Assessment
Global Investment Banks: profitability metrics and assigned scores
Source: Moody’s Banking Financial Metrics.
RBS’s asset risk is rapidly declining
The rapid decline in RBS’s overall asset risk is a result of the accelerated disposal of poor-quality assets at RBS Capital Resolution (RCR),
the group’s internal ‘bad bank’ (Exhibit 8).
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11 January 2016
The Royal Bank of Scotland Group plc: Substantial Restructuring Progress Underpins Our Positive Outlook
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Exhibit 8
The Group Has Rapidly Reduced RCR Legacy Assets
RBS: legacy asset portfolio (RBS Capital Resolution, RCR)
Source: RBS's Interim Management Statements and Data Supplements.
Further, this reduction has been achieved across all different asset classes (Exhibit 9), including non-performing, which had previously
been heavily provisioned. Some of these provisions have been reversed in the last several quarters owing to sustained favourable market
conditions and continued investor appetite for high-risk / high-yielding assets.
RBS has announced it will dismantle the RCR unit by the end of 2015, having reached the targeted reduction a year ahead of it its initial
three-year deadline.
Exhibit 9
RCR Reduction Has Been Achieved Across All Different Asset Classes
RBS: legacy asset portfolio (RBS Capital Resolution, RCR), funded assets breakdown
Source: RBS's 2014 Annual Report and Interim Management Statements.
The large reduction in non-performing loans accompanying the RCR wind-down has led to a tangible decline in the NPL ratio since
2013 (Exhibit 10).
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11 January 2016
The Royal Bank of Scotland Group plc: Substantial Restructuring Progress Underpins Our Positive Outlook
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Exhibit 10
Credit Quality Is Steadily Improving with Accelerated Wind-down of RCR
RBS: quarterly NPL ratio (RBS definition Risk Element In Lending (REIL) / Gross Loans)
Source: RBS Group's 2014 Annual Report and Interim Management Statements.
Notwithstanding this progress, RBS’s credit quality still lags domestic peers (Exhibit 11), which we believe stems in part from large
concentrations in the UK and Ireland real estate sectors. However, we expect the removal of non-performing assets from RBS’s balance
sheet to further reduce the group’s exposure to this and other troubled sectors, bringing the group’s NPL ratio closer in line with that
of its domestic competitors.
Exhibit 11
Further Bad Asset Disposals Will Bring NPL Ratio in Line With Domestic Peers’
Large UK banks: NPL ratios (IFRS definition)
Source: Moody’s Banking Financial Metrics and RBS's Interim Management Statements.
Targeted reduction in capital markets footprint is sizeable but go-forward business is not small
Both RBS’s overall capital markets revenue ($4 billion in 2014) and capital markets revenue as a proportion of total revenue (15%) were
at the low end of its global peer group in 2014, reflecting RBS’s strategy to downsize its CIB segment to £30 billion of risk-weighted
assets by 2019 (£78 billion at end of September 2015) by exiting product lines no longer complementary to its core commercial banking
business. In re-focusing the group’s activities towards its core UK market, RBS also expects to reduce the number of countries in which
it has investment banking operations to 13 by 2019 from 38 at the end of 2014.
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The Royal Bank of Scotland Group plc: Substantial Restructuring Progress Underpins Our Positive Outlook
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Exhibit 12
Capital Markets Operations Will Reduce as Restructuring Progresses
Global Investment Banks: capital markets operations
Bubble size indicates Share of Capital Markets Revenues / Total Revenues. Under Moody’s calculations, the revenues from RBS’s “go-forward” CIB segment have been used to approximate
Capital Markets Revenues. (*) denotes the RBS “go-forward” profile as presented by RBS using 2014 results. (**) denotes RBS’s pre-financial crisis positioning (i.e., in 2006) unadjusted for
foreign exchange movements
Source: Moody’s analysis using company reported data.
Despite this substantial reduction in its capital markets activities, and even with further targeted reductions, RBS will remain a large player
in certain capital markets product lines, such as Debt Capital Markets, which its management has committed to. While at steady state
these operations will represent a much smaller portion of its overall operations, they will not be negligible.
Funding and liquidity continue to improve on the back of heavy deleveraging
Funding and liquidity are credit strengths for RBS and continue to improve with its ongoing deleveraging. This is evidenced by the gradual
reduction in the stock of wholesale funding, making the group less reliant on confidence-sensitive funding sources (Exhibit 13).
Exhibit 13
RBS’s Loans Are More than Covered by Customer Deposits
Large UK Banks: gross loans / customer deposits
Source: Moody's Banking Financial Metrics and RBS's Interim Management Statements (Citizens is deconsolidated from balance sheet from Q3 2015).
Funded assets will continue to drop on the back of the completion of the Citizens’ disposal and further deleveraging, partly offset by
new lending (Exhibit 14).
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11 January 2016
The Royal Bank of Scotland Group plc: Substantial Restructuring Progress Underpins Our Positive Outlook
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Exhibit 14
RBS’s Funded Assets Continue to Trend Down
RBS: funded assets.
Source: RBS's Annual Reports and Interim Management Statements (Citizens is deconsolidated from balance sheet from Q3 2015).
RBS’s reliance on wholesale funding is declining and compares well with other large UK peers (Exhibit 15).
Exhibit 15
Funding Metrics Are More in Line with Domestic Peers
Large UK Banks: market funds / tangible banking assets
2012 and prior periods may not reflect the full, or any, derivatives netting adjustment (relative to that which is applied for 2013 onwards), due to limited disclosure.
Source: Moody's Banking Financial Metrics.
Liquidity is ample and of good quality (in line with the other UK banks) as a result of the implementation of the UK Prudential Regulation
Authority (PRA) interim liquidity regime since 2009, which has now converged into Basel 3 standards. The stock of liquid assets is more
than double the stock of both long-term and short-term wholesale funding (Exhibit 16).
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The Royal Bank of Scotland Group plc: Substantial Restructuring Progress Underpins Our Positive Outlook
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Exhibit 16
Liquid Assets Are More than Double the Group's Total Wholesale Funding
RBS: Liquidity Portfolio relative to short- and long-term wholesale funding (2010-Q3 2015)
Source: RBS's Annual Reports and Interim Management Statements (as per RBS’s standard reporting, funding excludes derivative cash collateral, end 2014:£25.3 billion end-2011: £31.8 billion).
RBS’s strong liquidity and funding positions are confirmed by its strong Basel 3 liquidity and funding ratios (Exhibit 17).
Exhibit 17
Regulatory Funding and Liquidity Metrics Confirm the Group’s Strong Position
RBS: Basel 3 liquidity and funding ratios
LCR
NFSR
Dec-12
Dec-13
Mar-14
Jun-14
Sep-14
Dec-14
Mar-15
Jun-15
Sep-15
>100%
115%
102%
120%
103%
n.a
104%
n.a
102%
111%
112%
112%
112%
110%
117%
115%
136%
117%
*NSFR for all periods end-2014 onwards have been calculated using RBS’s current interpretations of the revised BCBS guidance on NSFR issued in late 2014.
Source: RBS's Annual Reports and Interim Management Statements.
Execution risk from the ongoing restructuring is declining
RBS’s remaining restructuring initiatives continue to encompass complex operational challenges related to the restructuring of the group’s
core retail and commercial banking operations as well as the separation of Williams & Glyn and of its CIB business (Exhibit 18). The
implementation of structural reforms such as ring-fencing, to which RBS and the other large UK banks are subject, adds further complexity
to the group’s overall restructuring. Despite the execution risk of these initiatives, the scope for operational losses that could impair the
group’s strong franchise will narrow as the plan proceeds.
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The Royal Bank of Scotland Group plc: Substantial Restructuring Progress Underpins Our Positive Outlook
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Exhibit 18
Execution Risk of Restructuring Initiatives Will Diminish as Plan Proceeds
Initiative
Targeted timing
Expected outcome
RBS Capital Resolution (RCR) accelerated
winddown
Sale of US retail and commercial banking
operations (Citizens)
Consolidation of operations into three main
divisions, centralisation of control functions and
overall simplification of the operating model
Downsizing of investment banking operations
End of 2016 but it will be largely completed in
2015
Completed 30 October 2015; regulatory
deconsolidation expected from Q4 2015
New management structure is already in place
but project is ongoing
Release of £12 billion of RWAs and
improvement in asset quality
Release of c. £67 billion of RWAs and reduction
of Non-UK operations
Simpler and more efficient organisational
structure
Expected to be completed by the end of 2019
Cost-rationalisation initiatives
Ongoing
Sale of international private banking operations
End of June 2016
IPO of Williams & Glyn (agreed with, and required
by, the EU)
Target IPO in 2016 and full exit 2017
RWA reduction by 55% to £30 billion (end-Sep
2015 to target 2019), Funded Assets reduction
by 65% to c.£80 billion (end-2014 to target
2019) and reduction
Cost-to-income ratio <50% at end-state; CIB
Go-forward ≈ 55%
Limited RWA reduction / reduction of non-UK
presence
Limited financial impact / disposal of part of
domestic retail and SME operations agreed with
the EU
Source: RBS's Investor presentations
The group’s IT infrastructure, which has led to a number of high-profile incidents and has been subject to years of underinvestment, poses
considerable scope for operational risk. Management has also committed to strengthening the group’s control and risk management
capabilities. Remediation will consume management time that could be utilised to focus on the group’s core operations, particularly at
a time of increasing competition in the domestic market and still high regulatory uncertainty in areas such as TLAC.
RBS’s asset-risk assessment continues to capture the risks resulting from a number of pending investigations, which could ultimately
lead to large fines as well as other regulatory actions, which are uncertain in both timing and magnitude (Exhibit 19). We believe that
these outstanding matters are manageable but will continue to constrain the standalone credit assessment until a further reduction in
the uncertainty driven by the group's ongoing restructuring and high-profile pending litigations is achieved.
Exhibit 19
Pending High-Profile Litigations and Regulatory Reviews Will Continue to Weigh on Asset Risk
RBS: List of main high-profile pending investigations
Litigation
Description
Major involved
regulators
US Mortgage securities (FHFA) RBS has provisioned $2.5 billion. The claim is likely to
be a multiple of that figure
US Mortgage securities (non
No estimates of amounts or timing provided.
FHFA)
UK conduct of business
Further provisions for Payment Protection Insurance
(PPI) and Interest Rate Hedging Product (IRHP) redress
may be required.
LIBOR, benchmark rates
Litigation in some jurisdictions still outstanding.
UK competition
Review on treatment of small corporate clients
Moody's risk
assessment
High risk
High risk
FCA
Medium risk
FCA
Medium risk
Medium risk
Source: RBS's 2014 Annual Reports and Interim Management Statements.
Finally, the firm’s asset risk continues to incorporate the still relatively sizeable capital markets operations and the execution risks of
achieving the large targeted reduction in capital markets activities (Exhibit 20).
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The Royal Bank of Scotland Group plc: Substantial Restructuring Progress Underpins Our Positive Outlook
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Exhibit 20
Targeted Capital Markets Reduction Is Sizeable and Will Take Time To Complete
CIB reduction (Funded Assets left axis, RWAs right axis)
Source: RBS's 2014 Annual Reports, Interim Management Statements and CIB Update Investor Presentation (12 November 2015).
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The Royal Bank of Scotland Group plc: Substantial Restructuring Progress Underpins Our Positive Outlook
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Moody's Related Research
Credit Opinions:
»
The Royal Bank of Scotland Group plc
»
Royal Bank of Scotland N.V.
»
Ulster Bank Limited
»
Ulster Bank Ireland Limited
»
Citizens Financial Group Inc
Issuer Comments:
»
RBS’s Plan to Shrink CIB Will Make the Group Less Risky, but Is Costly and Complex, Nov 2015 (1010071)
»
RBS Sells Its Residual Stake in Citizens, a Credit Positive for Both Banks, Nov 2015 (185538)
»
Q3 2015 Results: Restructuring Advances But Continues to Weigh on Profit, Oct 2015 (1009619)
»
Q2 2015 Results: Restructuring and Litigation Charges Continued to Erode Operating Profits, Jul 2015 (1006987)
»
Q1 2015 Results: Litigation, Conduct and Restructuring Charges Keep Results in the Red, Apr 2015 (1004831)
»
RBS Sale of Additional Shares in Citizens Financial Is Credit Positive, Mar 2015 (180221)
»
RBS Announces Further Restructuring of Its Operations, a Credit Positive, Mar 2015 (179508)
»
Q4 2014 Results: Back in the Red Due To Write-downs and Further Conduct, Litigation Costs, Feb 2015 (1003417)
»
Royal Bank of Scotland Sale of Irish Real Estate Portfolio Is Credit Positive, Dec 2014 (178318)
Credit Focus reports:
»
Wind-down of Legacy Assets Has Reduced but Not Eliminated Tail Risk, Oct 2015 (1008546)
»
Successful Execution of Group Restructuring Could Ease Credit Constraints, Aug 2015 (1007224)
»
Restructuring Progresses but Still Weighs on Credit Profile, Nov 2014 (1000061)
Banking System Outlook:
»
United Kingdom, Dec 2010 (129388)
Company Profiles:
13
»
Royal Bank of Scotland Group plc, Jun 2015 (182419)
»
Ulster Bank Limited, May 2015 (181141)
»
Ulster Bank Ireland Limited, Jan 2014 (162191)
11 January 2016
The Royal Bank of Scotland Group plc: Substantial Restructuring Progress Underpins Our Positive Outlook
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Endnotes
1 Citizens Bank, N.A., LT deposits A1 stable, LT senior unsecured Baa1 stable, BCA a3; and Citizens Bank of Pennsylvania, LT deposits A1 stable, BCA a3.
2 Risk Element in Lending (REIL) is RBS’s internal definition of non-performing loans.
3 The Dividend Access Share (DAS) was created in 2009 when the UK government injected £25.5 billion of equity into RBS in the form of B shares and RBS
entered into the Asset Protection Scheme (APS) and the Contingent Capital Facility ('CCF') with the UK government. The DAS was created to provide
preferential dividend rights to the UK government on the new capital support provided. RBS exited the APS in October 2012 and, reflecting further
progress on its capital plan, was able to terminate the £8 billion CCF with HMT in December 2013.
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The Royal Bank of Scotland Group plc: Substantial Restructuring Progress Underpins Our Positive Outlook
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REPORT NUMBER 1011844
15
11 January 2016
The Royal Bank of Scotland Group plc: Substantial Restructuring Progress Underpins Our Positive Outlook
FINANCIAL INSTITUTIONS
MOODY'S INVESTORS SERVICE
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[email protected]
16
11 January 2016
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The Royal Bank of Scotland Group plc: Substantial Restructuring Progress Underpins Our Positive Outlook

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