Royal Bank of Scotland (LSE: RBS) is probably the most hated company in the UK. Nearly a decade after its taxpayer bailout, the bank is still struggling to rebuild its reputation. This process has not been helped by claims that the firm helped push small companies out of business, rather than helping them, following the 2009 crisis.
There’s also a substantial multi-billion pound US Department of Justice liability overhanging the bank. However, this is the final significant issue and management is confident that it can reach a settlement deal before next February.
An agreement would mark a key point in RBS’s turnaround. Estimates for the sum that the lender may have to pay the justice department range from £1bn to £5bn, but once an agreement is reached, RBS will finally be able to move on from the crisis.
And if you strip out all of the bank’s legacy issues, the lender has all the hallmarks of a great long-term investment.
Stronger than ever
Over the past decade, RBS has transformed itself from a basket case, into a profitable and well-capitalised lender. Tens of billions of pounds of risky assets have been disposed of while billions more have been paid out in PPI redress and fines from regulators.
Now, with PPI claims winding down, and the last of the big settlements on the horizon, these overhangs are about to vanish, leaving investors with an attractive opportunity.
At the end of October, RBS reported its common equity Tier 1 ratio, a measure of financial resilience, jumped to 15.5% in the period from 14.8% at the end of June. Analysts are predicting further reserves growth next year. A Tier 1 ratio of 17% is pencilled in for 2018.
What’s more, RBS has now turned a profit for three consecutive quarters — the first time it has done so since 2008. For the third quarter, the bank reported a profit of £392m profit with earnings for the year so far now £1.3bn.
Next year, City analysts are even more optimistic about the bank’s forecast. A pre-tax profit of £3.7bn is projected, a goal that looks entirely reasonable based on this year’s performance. A decline in legacy and restructuring costs should help accelerate a return to profit.
A long turnaround
RBS’s turnaround is only just starting. Over the next three years or so, efforts to rebuild the business should begin to pay off, and as one of the UK’s four largest high street banks, the group should have no problem growing the business.
As RBS is already well-capitalised, hefty dividends could be on the cards to reward long-suffering investors.
Management has indicated that it is waiting to get the green light to return cash to shareholders, and like peer Lloyds, RBS could decide to return all excess capital to investors. In this scenario, I believe that the bank could pay out 100% of earnings per share, which based on 2018’s numbers is around 25p for a dividend yield of 9.3%.
So overall, I believe that over the next two decades, RBS’s restructuring will start to pay off and patient investors will be well rewarded.
