The market has soured on the RBS (LSE: RBS) share price in 2020. Shares in the lender have fallen around 54% year-to-date.
It’s easy to see why investors have decided to dump their holdings of the bank over the past few weeks.
The coronavirus crisis has had a significant impact on the UK economy and, as one of the country’s largest lenders, RBS is preparing for a substantial increase in loan losses as a result.
Management earmarked £802m to deal with an expected increase in defaults in the first quarter of the year, an increase of nearly 840% year-on-year. As a result, net profit for the quarter tumbled 59% to £288m.
Against this backdrop, the RBS share price may seem like a value trap. However, the company could offer a wide margin of safety at the current time. As such, it may be an attractive long-term investment.
RBS share price: undervalued
As well as the potential for increased loan losses as a result of the pandemic, RBS is also having to deal with low interest rates. In the first quarter, overall revenues declined 1.6%. Revenues may continue to stagnate if the Bank of England maintains its key rate at the lowest level in recent memory.
But despite these pressures, the RBS share price appears to offer less risk than many of its sector peers. The bank has relatively limited exposure to credit card lending, and management has been trying to improve lending standards in recent years.
What’s more, after more than a decade of rebuilding after the financial crisis, RBS’s balance sheet is relatively strong. So, it should be able to handle the jump in loan losses.
Nevertheless, despite these sector-leading qualities, the RBS share price is trading at a sector low. Shares in the lender are dealing at a price-to-book (P/B) value of 0.3. That’s compared to the financial services sector average of 0.5. That may suggest that the RBS share price offers a wide margin of safety at current levels.
Diversification
Of course, the bank’s growth may remain under pressure for some time. The coronavirus crisis is still rumbling on, and we do not yet know how significant the impact will be on the UK economy. It could be several years before economic growth returns to the level seen before the crisis.
However, the 54% decline in the RBS share price highlights that investor sentiment is fragile. As the economic fallout of the pandemic becomes clear, this could persist in the short run, but the valuation of the RBS share price could provide long-term investors with the opportunity to buy a high-quality business while it offers a wide margin of safety.
The best way to limit the risk of this investment going wrong, while being able to partake in any potential upside could be to own the stock as part of a diversified portfolio of shares. Owning companies in different industries and geographies is always a sensible investment strategy, but it could be even more critical in the current environment.
