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Is 5%+ yielder Royal Bank of Scotland a FTSE 100 dividend star or an investment trap?

The investment community finally got an excuse to put the bubbly on ice when Royal Bank of Scotland Group (LSE: RBS) announced in August, after years of baited breath, that it was reinstating the dividend.

It’s been a long and often painful journey as the FTSE 100 bank dealt with the fallout of the banking crisis of a decade ago. But news that it was paying a 2p per share interim dividend — the timing of which is dependent upon settlement of misconduct issues with US authorities — marks a new dawn in RBS’s story.

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Following the news, City analysts have been predicting sterling payout growth over the next couple of years. A total dividend of 6.8p per share is touted for 2018, which is expected to shoot to 12.9p next year. Consequently, the forward yield of 2.7% explodes to an outstanding 5.2% for 2019.

PPI problems are worsening

However, I’m less than convinced that RBS will have the strength to meet these heady predictions, even if the number crunchers suggest it can draw support from single-digit earnings growth this year and next.

In the article I referenced above, my colleague Roland Head pays heed to the £801m litigation charge that the company had endured from January to June, more than double that of the corresponding 2017 period. It’s true that the PPI deadline 11 months from now will finally draw a line under the painful saga for Britain’s banks, but in the meantime, the likes of RBS can expect these penalties to swell as claimants rush in ahead of the forthcoming cut-off date.

This is particularly problematic for RBS given the financial institution’s fragile balance sheet. It may have celebrated squeezing past the Bank of England’s capital stress tests last November, the bank having fallen at the hurdle a year previously, but it may struggle to pass the challenge this autumn.

As chief executive Ross McEwan commented last year: “Until we have resolved our remaining major legacy conduct issues and noncore portfolio interestswe will continue to show stress test results weaker than our long term targets.”

Revenues failing to rev up

A pressured balance sheet isn’t the only reason to be cautious over RBS’s dividend outlook, though, as it’s also struggling to create strong revenues growth. Indeed, total income actually fell 3% in the first six months of 2018 to £6.7bn.

This income drop — allied with the aforementioned impact of fresh PPI redress costs — caused operating profit before tax to also sink around 3% in the first half to £1.83m. Those City predictions of sustained earnings growth over the next couple of years are looking just a little bit fragile, in my opinion. And particularly so, if Britain’s exit from the European Union drags on for some time longer, or the country catastrophically falls out of the trading bloc without a deal.

Those medium-term dividend yields, as well as RBS’s low, low valuation with a forward P/E ratio of 9.3 times, may make the bank an appetising selection for Footsie investors at first glance. However, the chances of it disappointing on both the profits and dividend fronts are very high, in my opinion. And, for this reason, I think it should be avoided at all costs.

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Royston Wild 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.