DBRS Comments on RBS’s Agreement to Terms of APS and 3Q Results, Senior at 'A', Trend 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 Group’s announcement that it has agreed to revised terms relating to the U.K. Government’s Asset Protection Scheme (APS) and release of 3Q 2009 financial results. The trend for all ratings remains Stable. The ratings remain at the floor, which DBRS has assigned for critically important banks operating in the U.K.

Today’s comment follows last week’s announcement that RBS has agreed to key terms with HM Treasury regarding revisions to the APS. Among key differences from original terms as announced in February 2009, are a reduction in the opening asset pool from GBP 325 billion to GBP 282 billion and an increase in RBS’s first loss exposure to GBP 60.0 billion from GBP 42.2 billion. In return, RBS’s participation fee has been reduced significantly. RBS will be subject to an annual fee of GBP 700 million, for the first three years, and then GBP 500 million annually thereafter, with a minimum cumulative fee of GBP 2.5 billion. This is a significant change from the GBP 6.5 billion upfront fee which was originally proposed. Importantly, the Company retains both current and future deferred tax assets (DTA). Although the first loss position has increased in the revised APS scheme, DBRS sees the benefits of the lower fees and the retention of the DTA as these will reduce the cost burden of the APS. Moreover, given the improvements in the operating environment, the progress RBS has made in reducing non-core assets, and the stable performance in the core businesses, DBRS views the revised APS as a means to insure against catastrophic loss.

Furthermore, the revised APS scheme significantly improves capitalisation. HM Treasury has committed to a GBP 25.5 billion initial capital injection in the form of B shares. As a result of the APS and B share issuance, RBS’s pro-forma 3Q 2009 core Tier 1 ratio will be 11.1%, an increase from 5.5%, at 30 September 2009. Further, HM Treasury has committed to subscribing to an additional GBP 8.0 billion of B shares should RBS’s core Tier 1 capital ratio decline below 5%, providing additional capital cover should stress scenarios materialise. In DBRS’s view, the increased capital and the flexibility gained from the GBP 8.0 billion capital commitment should allow RBS to manage the impact of the likely continued elevated impairments levels and rising risk-weighted assets from pro-cyclical effects. In sum, the APS should afford RBS the necessary time to restructure its business and ultimately restore RBS’ financial strength and stability on a standalone basis.

Concurrently, RBS announced certain divesture requirements from the European Commission in accordance with the State Aid process. Over the next four years, RBS will be required to divest the RBS branch-based business in England and Wales, the NatWest branches in Scotland, along with Direct SME customers across the U.K, RBS Sempra Commodities, its Global Merchant Servicing business and RBS Insurance. The required divestures will result in the disposal of 318 branches U.K.-wide, roughly 14% of the Group’s U.K. retail network and reduce RBS’s U.K. retail banking market share by approximately two percentage points. Although the required divestitures are considered noteworthy, given the scale of some of these businesses, DBRS still views the overall impact to the franchise as manageable. Moreover, the four year time horizon provides a level of comfort that RBS will be able to achieve maximum value from these transactions. Nonetheless, recurring earnings will be impacted. Based on 2008 results, these divestitures will reduce operating profits by some GBP 1.1 billion, thereby potentially lengthening the timeframe for RBS to return to profitability.

RBS’s 3Q 2009 results indicated a reduced operating loss of GBP 1.5 billion, down 57% from GBP 3.5 billion on a sequential quarter basis. Importantly, RBS’s core businesses generated an operating profit before impairments of GBP 2.4 billion, evidencing the resiliency of the RBS franchise. Operating profits from the core businesses totalled GBP 1.2 billion. The non-core business recorded an operation loss before tax of GBP 2.7 billion. Group-wide impairments remain elevated at GBP 3.3 billion; however were 30% lower on a quarter linked basis. The reduced impairment partially reflects the stabilisation in credit trends. However, impairment levels remained high at Ulster Bank and Citizens Bank, reflecting the ongoing challenging operating environment in Ireland and the U.S.

Despite a highly competitive environment for deposits, RBS was successful in stabilising NIM during the quarter at 1.75%. Incremental increases in retail deposits combined with lower lending volumes resulted in the Group’s loan-to-deposit ratio improving to 142% from 152% at year-end 2008. The Group continues to reduce its balance sheet, which is a principle theme of the restructuring plan. Non-core runoff continues to progress well, with non-core assets totalling GBP 220.2 billion at 30 September 2009, down some 32% from year-end 2008.

DBRS views the Group’s results for the third quarter as evidencing a degree of stabilisation in the operating environment of the Group’s core businesses. Nonetheless, DBRS remains cautious given the current point in the cycle. Continuing elevated levels of unemployment and the outlook for below trend recovery are likely to weigh on credit metrics through 2011. Moreover, DBRS remains concerned that the improvement in global capital markets, which has resulted in good results in the Group’s Global Banking & Markets segment, may prove unsustainable. Lastly, the Group remains exposed to significant losses from its non-core assets should the global economy and capital markets return to the severely distressed conditions of early 2009. However, the APS provides a ceiling on outsized impairments should these stressed conditions return and the projected initial capital injection provides substantial loss absorption ability.

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.