DBRS Comments on Royal Bank of Scotland Group plc’s Interim Results, Senior at A, Stable

DBRS has today commented that the ratings for The Royal Bank of Scotland Group plc (RBS, the Company, or the Group) and related entities, including the Company’s Senior Debt & Deposits rating of “A” are unaffected by the interim results for the first half of 2009. The Trend for all ratings remains Stable.

Today’s comment follows RBS’ announcement of an operating loss of GBP 3.4 billion for the first half of 2009. Included in this loss is a material impairment charge of GBP 7.5 billion partially offset by a pre-tax GPB 3.8 billion gain on redemption of its own debt. Importantly, total income for the half year was GBP 14.8 billion, a 27% increase over first half 2008. Further, after adjusting for the gain associated with the debt redemption, the Group recorded a pre-tax profit of GBP 15 million, excluding write-downs of goodwill and other intangibles. In DBRS’s view, while these results have been highly impacted by the difficult market conditions, the underlying results illustrate the strength of the core RBS franchise and its strong earnings generation ability.

During the first half of 2009, the Group realigned its operations to include a Core Group and a Non-Core division, which was set-up to house assets and businesses that are to be run-off or otherwise disposed of. For the half year, the Core Group reported total income of GBP 17.8 billion, a 25% increase from the comparable period in 2008, while operating profit before impairment charges was GBP 8.5 billion, up 57% from 2008. The solid results were driven by a strong operating profit in the Global Banking & Markets (GBM) division. Within GBM, operating profit increased significantly to GBP 5.1 billion reflecting strong performances in rates and currencies businesses while also enjoying the benefit from more favourable market conditions. Going forward, DBRS anticipates that as market conditions normalise, the earnings generation in GBM may decline to a more normal run-rate.

Operating profit before impairments in U.K. Retail declined 8% to GBP 877 million, owed to lower non-interest income attributed to lower loan volumes. Within U.K. Corporate, operating profit before impairment charges declined by 16% to GBP 872 million, attributed to higher funding costs and depressed deposit margins. DBRS views the results from the Core Group as especially enlightening as they illustrate RBS’ earnings power, importantly, on a going-forward basis, as the composition of the Core Group is not expected to change during the Group’s restructuring efforts. Although there are indications of a degree of stablisation in RBS’ core markets, DBRS expects that core underlying performance will be pressured by sluggish loan demand, elevated funding costs and compressed margins, while credit costs are likely to remain above historic levels. Further, the Group’s overall financial performance over the medium-term will remain pressured by the Non-Core division, in which half year results included a GBP 9.6 billion operating loss, largely driven by losses from trading activities of non-core assets and GBP 5.3 billion of impairment charges.

Credit costs remained elevated. During the half year, the Core Group recorded an impairment charge of GBP 2.2 billion, or three times those incurred in H1 2008. The increase was driven by losses in the unsecured personal loan book owed to higher unemployment and declines in commercial property values in Ireland, the U.K. and the U.S. Impairments, however, in the Non-Core division were substantially higher, totalling GBP 5.3 billion for the first half, driven by continued weakness in the property and construction loan portfolios. DBRS views the level of impairments on the Group level as sizeable, but is also mindful that the Core segment was able to generate pre-provision profits which were four times impairments. DBRS expects continued elevated impairments; however, the implementation of the Government Asset Protection Scheme (GAPS) later this year, will limit the overall exposure to a first loss amount of GBP 20 billion. Approximately 70% of the impairments and write-downs incurred in the first half are attributable to assets covered by the Asset Protection Scheme.

DBRS views capitalisation as sufficient, given the government support including the forthcoming GAPS. Core Tier 1 ratio was 6.4% at 30 June 2009, compared with 5.3% a year earlier. Capital ratios have benefited from the debt exchanges completed during H1 2009, the GBP 5.3 billion placing and open offer, and a 6% reduction in risk-weighted assets from year end. Capitalisation is expected to increase significantly with the completion of the GAPS.

Funding and liquidity remain acceptable and are bolstered by the various actions of the U.K. Government. Customer accounts, which provide the foundation to the liquidity profile, totalled GBP 415.3 billion at 30 June 2009. Liquidity is enhanced by (liquidity) reserves totalling GBP 121 billion, which were prudently increased some 34% from the comparable period in 2008. RBS continues to lengthen its maturity profile with 47% of wholesale funding maturing in more than one year.

The Group continues to make progress on reducing its balance sheet, which is a principle theme of the restructuring plan. Over the past 18 months, balance sheet assets declined 23%, on a constant currency basis. Non-core run-off continues to progress well, with non-core assets totalling GBP 231 billion at 30 June 2009, down from GBP 325 billion at year-end 2008. The anticipated participation in the GAPS will help RBS in the balance sheet reduction efforts. RBS expects to receive credit protection on GBP 294 billion of assets through GAPS.

The trend on all ratings is Stable, as the ratings are at the level that DBRS has set for the floor of Critically Important Banks (CIBs) in the U.K. The floor ratings reflect DBRS’s opinion that governments will support certain large banking organizations that are critically important to the functioning of their financial markets and maintaining the flow of credit.

Note:
All figures are in GBP unless otherwise noted.

The applicable methodologies are Analytical Background and Methodology for European Bank Ratings, Second Edition and Enhanced Methodology for Bank Ratings – Intrinsic and Support Assessments, which can be found on our website under Methodologies.

This is a Corporate (Financial Institutions) rating.