Booming Property Market Lifts Royal Bank of Scotland Group plc

RBSRoyal Bank of Scotland Group (LSE: RBS) (NYSE: RBS.US) cheered investors this morning with news that the bank may not lose as much money on some of its bad loans as expected.

RBS shares rose by around 4% when markets opened, thanks to news that the bank expects to release impairments worth around £500m during the third quarter.

What does this mean?

Today’s news mostly relates to the bad mortgage loans held by the RBS ‘bad bank’, RBS Capital Resolution (RCR).

Many of these loans relate to the Irish property market, which is currently booming. This means that the value of the properties the RCR loans relate has risen.

As a result, RBS expects lower default rates on these loans, and has reduced the impairment provisions on the loans by around £300m during the third quarter.

RBS also said that it managed to sell £9bn worth of legacy debt securities for a loss of ‘just’ £200m. This is actually good news, as it removes a load of toxic assets from the bank’s balance sheet; this should result in an increase in the bank’s Common Equity Tier 1 Ratio, a key regulatory measure.

Not a cash gain

Although today’s news is positive for RBS, it’s important to remember that these are not cash gains.

Impairment provisions are expected future losses from assets, such as loans, which may not be repaid in full. When an asset is impaired, the impairment provision is entered into the bank’s income statement as an expense.

If the impairment is reversed, this shows as income — so while today’s news should boost RBS’s reported profits, it won’t help the bank to fund a dividend.

What about real profits?

RBS said today that Corporate & Institutional Banking revenues had been disappointing, but didn’t mention its much larger Personal & Business or Commercial & Private Banking divisions.

My suspicion is that profits from these divisions could be fairly flat in Q3, but this isn’t necessarily bad news, as RBS is already reasonably profitable: cost-cutting and winding down its bad bank are RBS’s most important goals.

Buy RBS on today’s news?

I’m broadly bullish on RBS over the medium term, but in my view, today’s news has left the bank’s shares looking quite fully valued, with a forecast P/E of just over 12.

Given that there is little chance of meaningful dividend until 2016, I think that’s enough, for now, so I’d rate RBS as a solid hold.

I reckon there are better buys elsewhere in the banking sector.

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Roland Head has no position in any shares mentioned. The Motley Fool UK has no position in any of the shares mentioned. We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors.