At a time when most market sectors are taking a hit, banking is not immune. The big FTSE 100 banks are having to set aside large provisions for bad loans. Most are also seeing a hit to revenue due to low consumer and corporate spending. Yet despite this, I am positive on the Royal Bank of Scotland (LSE: RBS) share price.
The year-to-date performance has been anything but positive. The share price of RBS has fallen 53%. For comparison, Lloyds Banking Group is down 50% and Barclays is down 43%. So what is the silver lining here?
Net interest margin
I have spoken before of using the net interest margin as a good gauge of bank profitability. After all, the traditional banking model is to take money via deposits and lend that money out as loans. The difference between the interest paid on deposits versus the interest charged on loans was the profit. In modern times, this has become known as the net interest margin (NIM).
In the first quarter of this year, the NIM for RBS was 1.89%, down only 0.04% from the end of 2019. This impresses me, given that the Bank of England has slashed rates to 0.1% from 0.75% in the same quarter. Some of this impact will be delayed, but ultimately if RBS can maintain the NIM around this level, that is a very encouraging sign. It should help the bank to make good revenue from a core banking product, and be less reliant on more risky operations.
Many people’s eyes glaze over when they hear the term CET 1 capital ratio used. I do not blame them! But in fact it is a fairly simple concept once broken down, and very useful. The capital ratio basically measures what proportion of the total assets held are different grades. Tier 1 is the highest grade, so includes liquid assets such as cash, retained earnings, stock etc. In order for a bank to withstand a crisis, regulation says this Tier 1 capital should be at least 4.5% of total capital.
The ratio for RBS is currently 16.6%, the highest of the FTSE 100 banks. It is often seen as a measure of solvency and the ability for the bank to withstand hard times. Given the strong figure, this makes me confident in the way the bank is being manged. It also makes me lean towards RBS over other FTSE 100 banks with lower CET 1 ratios.
RBS = partially government-owned
A final point why RBS is a buy to me is that fact that it is still predominately government-owned. The government owns about 60% of the business. Now while this does not make RBS a worthy buy alone, it does provide a reassurance about the downside risk when buying the stock. The government is unlikely to let a firm it has the majority stake in go bust.
This does not mean the bank will get special treatment, but it does give me more confidence in investing when comparing it to other FTSE 100 bank stocks.
The resilience of the NIM, the strong CET 1 ratio and the fact that the government is a shareholder all impresses me with RBS. This makes it my current favorite FTSE 100 bank stock, and very worthy of an investment.
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Jonathan Smith owns shares in Lloyds Banking Group. The Motley Fool UK has recommended Barclays and Lloyds Banking Group. 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.