One Reason Why I Wouldn’t Buy Royal Bank of Scotland plc Today

Today I am looking at why investors should be concerned by Royal Bank of Scotland’s (LSE: RBS) (NYSE: RBS.US) fragile balance sheet.

A less-than-capital stock selection

In my opinion, Royal Bank of Scotland’s flaky capital position should cause the alarm bells to ring for the company’s beleaguered shareholders. Indeed, the bank’s fully loaded Common Equity Tier 1 (or CET1) ratio, according to European Union Basel III directives, rang in at just 9.4% as of the end of March, raising chatter that the firm will be forced into drastic action to get this figure marching higher.

Indeed, forecasters do not expect the situation to improve markedly any time soon, and broker Investec expects the ratio to remain at an underwhelming 9.7% and 10.5% as of the end of 2014 and 2015 respectively.

Worsened by the firm’s weak capital loadings, the opinion in the City is becoming increasingly pessimistic over whether Royal Bank of Scotland will be able to shell out a dividend this year as previously expected. And the firm’s payout prospects beyond this year hardly set the world on fire, either: a forecast dividend of 1.7p per share for 2015 creates a miserly yield of 0.5%, well below the current 3.2% FTSE 100 average.

The company is engaging in huge cost-saving exercises and asset stripping in order to bolster capital, including the planned flotation of its RBSCitizens Bank operations in the US in the near future. In the meantime the American entity is engaging in rounds of streamlining boost the balance sheet, and announced the sale of scores of retail branches in Chicago and certain small business and middle market relationships to US Bank.

Royal Bank of Scotland advised in last month’s interims that expenses fell 6% during January-March to £3.2bn, advising that “incremental cost savings have been delivered principally from tactical cost control initiatives‘ and that ‘the benefits from strategic cost reduction initiatives will feed through in later quarters”.

Still, persistent problems across its core operations mean that lost revenues continue to outpace the effect of such cost-stripping. Against this backdrop the firm looks likely to struggle to build up its capital reserves in accordance with regulatory requirements.

Investors should be aware of the huge constraints which Royal Bank of Scotland’s precarious cash situation is likely to mean for dividend seekers. With the bank’s peers also on a much sounder footing — Lloyds Banking Group and HSBC Holdings currently carry CET1 ratios of 10.7% — I believe that more robust banking picks are out there.

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> Royston does not own shares in any of the companies mentioned in this article.