RBS reported FY 2013 pre-tax losses of €8.3bn (2012: -£5.2bn), which was higher than consensus estimates (-€6.7bn) though reflected one-off legacy/redress provisions of £3.8bn and accelerated impairment charges of £4.8bn relating to its internal bad bank. Operating profits in the markets business declined 58% to £638 million, primarily due to the smaller balance sheet and restructuring. The year-end CT1 ratio declined to 10.9% (2012: 14.4%) or 8.6% on a fully-loaded Basel III basis.
<b>Strategic review:</b> As we expected, Ulster bank is to remain committed to the Irish market and has announced a new loan fund of £1.7bn. Ulster’s Northern Irish business is set to form a closer alignment with RBS’s UK operations. However the group continues to explore opportunities in relation to its RoI franchise, but intends to reposition the business as a challenger to the domestic pillar banks. From speaking to management this morning, we understand that the core Ulster bank should return to profitability this year (excluding one-off charges) with the focus on alleviating legacy issues over coming months such as the tracker mortgage drag.
<b>Ulster Bank:</b> Operating losses in 2013 rose to £1,457m (2012: £1,040m) after impairment charges of £1,774bn (2012: £1.4bn). However excluding the (£911m) impact of additional RSS Capital Resolution (internal bad bank) charges, the operating performance improved by £494m. Ulster’s loan to deposit ratio declined to 120% (2012: 123%) with net loans falling to £26bn (2012: £27.4bn) and deposit balances of 21.7bn (2012: £22bn). Non-performing loan remained broadly stable (y-o-y) at £8.5bn (coverage ratio of 64%). In addition, impairment charges rose to £3.0bn in the non-core Ulster unit (2012: £983m).
However on a quarterly basis the underlying fundamentals in the core Irish business continue to improve, with margins rising in Q4 by 24bps to 210bps (primarily liability driven) while expenses declined by 4% to £136m. The Q4 mortgage impairment charge decreased to 50bps (Q4 2012: 280bps) while we understand that mortgage arrears have continued to decline and have now been falling for ten consecutive months.
<b>Outlook:</b> RBS continues to see signs that the UK economy is recovering with increased levels of activity and customer confidence, however the lag between the recovery and its franchises is expected to grow given low interest rates, excess liquidity and continued deleveraging. The group expects margins to expand in 2014 but while the strategic repositioning of its markets business has progressed well, the regulatory environment remains challenging.
<b>Our view:</b> RBS appears to be focused on de-risking its business model, targeting a less capital intensive low cost retail & corporate franchise going forward (more akin to the Lloyd’s model with some residual markets business). This restructuring should enable the bank to generate returns (targeting 12% R0E) above a lower (less risky) cost of equity in the future. Though the transformation is not without execution risk especially given the tough regulatory pressures of the PRA. While underlying trends in the core Ulster bank continue to recover, we would not be surprised to see the bank seek to merge with other small players in the coming year as it seeks scale. In this regard, ptsb’s good-bank may potentially offer an opportunity.
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