The headline on the Financial Times article about Royal Bank of Scotland’s (LSE: RBS) Q3 results this morning ran ‘RBS swings into profit as bank draws line under financial crisis’. Yes, it took a mere decade but the bank is finally back in the black.
Well, sort of. Management isn’t targeting its first annual profit since 2007 until next year and qualifies that this target is based on the still-to-be-decided size of its expected multi-billion-pound settlement with the US Department of Justice over the mis-selling of mortgage backed securities in the dark days of the financial crisis.
There’s still no concrete timeframe for when this settlement will conclude, but some analysts expect it to be twice the £4.2bn payout agreed with the Federal Housing Finance Agency earlier this year. The bank has already stashed £2.8bn for the expected fine, but if it’s substantially over this mark, expect that first annual profit to be pushed back yet another year.
That said, management is doing well in fixing the issues it actually has agency over. In the first nine months of the year, its heavily adjusted cost-to-income ratio fell from 65.9% to 53.9%, while its statutory return on tangible equity (RoE) flipped from a substantial negative to 5.2%. This means the bank’s 2020 target of a sub 50% cost-to-income ratio and RoE over 12% remain achievable.
However, there is still a lot of heavy lifting to be done. With the mega-fine threatening to wipe out several years’ worth of underlying profits, plenty of costly restructuring still ahead, and the prize at the end of the road a highly competitive retail banking market with low interest rates equalling low profitability, I see many better places to invest my money than RBS, even if it is finally, possibly, back on the right track.
An already profitable alternative
Much more attractive to me is a supplier of RBS, Alfa Financial Software (LSE: ALFA). The tech firm provides software to the asset finance sector, which covers everything from consumer auto loans to firms purchasing machinery on credit.
As the regularly shambolic performance of big banks’ IT systems illustrates, the finance industry does not have a great track record of designing its own software. That’s where Alfa comes in, with a cloud and computer-based platform that is tailored to a customer’s specific needs and often comes with a price tag much lower than doing it in-house.
Unsurprisingly, this offer has been a hit with car companies, banks and even Uber. In the half year to June, its first reporting period as a public company, revenue was up 29% in constant currency terms to £43.9m while adjusted operating profits were up 20% to £20.2m.
More than half of the firm’s revenue comes from the early years of a contract as it works to embed its software in clients’ systems and train their personnel in using it. However, over the long term, there is considerable potential for Alfa to increase its percentage of recurring revenue, which brought in £10m in H1 compared to only £2.4m in the year prior.
Alfa’s shares aren’t cheap at 45 times forward earnings but with no debt, high profitability and huge growth potential, I see plenty to like.
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Ian Pierce has no position in any of the shares mentioned. The Motley Fool UK has no position in any of the shares mentioned. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.