Shares of Royal Bank of Scotland (LSE: RBS) made rapid gains to over 500p during 2009 as hopes of a speedy recovery from the financial crisis ran high. That early confidence proved too optimistic. Indeed, with the shares now at around 300p, investors who bought between late spring 2009 and early summer 2011 are sitting on fairly hefty long-term losses. And without even the succour of a dividend.
However, a decade on from the financial crisis, is the FTSE 100 pariah bank finally poised to start delivering for investors? Several of my Foolish colleagues have begun to warm to RBS, having previously been cool on it, while long-time arch-banking-bear Neil Woodford has been buying shares in recent months.
Improving outlook
Sentiment has also improved among City analysts with buy/sell recommendations having now swung to 7/3 from 1/13 this time last year, according to data from Thomson Reuters. RBS’s shares have advanced almost 40% over the last 12 months, but upgrades to earnings forecasts mean the stock is still trading on a relatively low earnings multiple of 11.5 times the 2018 consensus.
A forecast dividend of over 3% also provides grounds for confidence. And Morgan Stanley, which this week upgraded RBS to ‘overweight’ from ‘equal-weight’ and increased its target price to 330p from 265p, reckons the bank could afford share buybacks equivalent to 15%-20% of its market capitalisation over time on top of dividends.
The end of RBS’s major litigation costs is also in sight, with the bank expected to settle with the US Department of Justice on the mis-selling of mortgage-backed securities in the next few weeks. While the sum may be substantial — estimates range from £1bn to £5bn — the removal of the uncertainty could be a catalyst for a further improvement in investor sentiment and share price gains.
Macro risk
I see a fair bit of merit in the bull analysis of RBS and I was particularly struck by the suggestion of the Morgan Stanley analysts in their note this week that “substantial deleveraging in its corporate book and less exposure to consumer should see more resilient asset quality performance if macro were to deteriorate.”
However, while RBS might be resilient, it wouldn’t be immune to a significant deterioration. And I believe the risk of such a deterioration has become relatively high. Interest rates are beginning to rise, which is generally beneficial to banks, but the downside of rising rates could well be extremely severe at the present time.
Many businesses that would otherwise have gone to the wall during the financial crisis have been able to limp on only with the crutch of low interest rates. Insolvency specialist Begbies Traynor reported in November that the number of UK companies in “significant” financial distress had reached “unprecedented levels.” With consumer debt also at unprecedented levels, I think rising interest rates are likely to spark a marked increase in both corporate and personal debt defaults — and impairments for banks.
In view of the risk of earnings and dividends being hobbled, and not forgetting that the government still has a 70% shareholding to dispose of, I’m inclined to consider RBS a stock to sell for 2018.
