DBRS Comments on RBS’s 2012 Results and Business Alignment Measures; Senior Unchanged at “A”, Stable

DBRS Ratings Limited (DBRS) has today commented that the ratings for The Royal Bank of Scotland Group plc (RBS or the Group) and related entities, including its Senior Debt & Deposits rating of “A” are unaffected by the Group’s announcement of full year 2012 results and certain proposed “business alignment” measures, including the partial IPO of its U.S. subsidiary, RBS Citizens Financial Group. DBRS assigns an Intrinsic Assessment of BBB (high) to RBS, and the final Debt ratings of “A” reflect DBRS’s designation of RBS as a Critically Important Banking organisation (CIB) in the U.K. RBS’s A Senior Debt & Deposit ratings are at DBRS’s floor for CIBs in the U.K. The trend for all ratings is Stable.

Despite the backdrop of a weak U.K. economy and a challenging global economy, RBS reported an improvement in underlying operating profit. However, the Group’s overall performance continues to be affected by sizeable conduct and restructuring costs. RBS reported an underlying operating profit of GBP 3.5 billion, up from GBP 1.8 billion a year ago. Underlying results benefited from a good performance within the Core Business, as well as continuing improved operating results in Non-Core, driven by a 43% decline in impairments and lower operating expenses. Overall, for the full year 2012, the Group reported an attributable loss of GBP 6.0 billion compared to a loss of GBP 2.0 billion in 2011. Even excluding the GBP 4.6 billion negative impact of movements in the fair value of its own debt, RBS would have reported a loss before tax of GBP 0.6 billion. Significant charges included further Payment Protection Insurance (PPI) provisions of GBP 1.1 billion, integration and restructuring costs of GBP 1.6 billion and the LIBOR fine of GBP 381 million.

RBS also provided some information regarding measures under consideration to further reshape the Group and strengthen capital. Specifically, the Group announced it would target a partial IPO of Citizens within 2 years, as well as a further reduction in Markets RWAs. DBRS considers these measures as overall neutral for the Group’s credit profile. The proposed actions would enable the Group, which estimates its fully-loaded Basel III Core Tier 1 to be currently at 7.7% (at the low end of the peer group), to reach the higher GSIFI and ICB standards ahead of schedule, which would be a positive development and potentially alleviate concerns that the Financial Policy Committee and/or FSA may have on capital adequacy. However, even though the measures do not dramatically shift the Group’s business mix, they create some uncertainty with regards to the Group’s long-term strategic direction.

The Group continued to make progress in de-risking the balance sheet. Indeed, the Non-Core operations’ third party assets (excluding derivatives) were down 39% to GBP 57.4 billion from GBP 93.7 billion a year ago. Nevertheless, the Group faces ongoing challenges in its clean-up work, including the stalled E.C. mandated branch sale, the reputation and financial cost of conduct failures (PPI, LIBOR, SME swaps) and concentrations remaining in the balance sheet (for example, property and construction loans fell by 12%, but still represented 17.7% of gross loans in 2012).

In the 2012 results, the Core Business benefited from improving performance within Markets and U.S. Retail & Commercial (R&C), as well as solid cost control and lower credit costs. Operating profits for 2012 in the Core Business were GBP 6.3 billion, 5% higher than 2011. The softening of the U.K. economy constrained revenues with both U.K. Retail and U.K. Corporate seeing reduced demand and customer activity. Moreover, while margins were stable, the subdued demand for lending resulted in a reduction in average interest earning assets. As a result, income (revenues) was 4% lower year-over-year (YoY) at GBP 25.5 billion. Operating costs were reduced 4% YoY at GBP 13.7 billion with costs lower in all businesses with the exception of Wealth, which saw a slight rise due to investment in developing new products and capabilities, and U.S. R&C primarily due to the U.S. LIBOR settlement. The cost of credit continues to trend favourably supporting earnings. Impairment costs declined 13% with improving trends in U.K. Retail and US R&C. From DBRS’s perspective, the ability of the Core Businesses to generate sustainable earnings is critical for the Group in rebuilding its intrinsic strength. In DBRS’s view, the 2012 results illustrate that RBS’s Core franchises still have considerable and rather resilient underlying earnings capacity.

Liquidity and funding continue to strengthen, while capital is acceptable. The Group’s loan book is completely funded with deposits with the Group’s loan-to-deposit (LTD) ratio at 100%, while the Core Bank’s LTD ratio stood at 90%. Retail & Commercial deposits were up 2% YoY to GBP 401 billion, while wholesale deposits were allowed to run-off declining GBP 11 billion. As a result, Group-wide customer deposits were marginally lower YoY at GBP 434 billion. Positively, usage of short-term wholesale funding continues to decline. In the twelve months to 31 December 2012, short-term wholesale funding was reduced by GBP 60 billion to GBP 42 billion. Meanwhile, the Group’s liquidity buffer remains sound at GBP 147 billion, or 3.5x short-term wholesale funding at year-end. With regard to capital, RBS’s Core Tier I ratio stood at 10.3% at year-end 2012, up from 9.7% a year ago (excluding the capital relief from the Asset Protection Scheme, which lifted the ratio to 10.6%).

Notes:
All figures are in GBP unless otherwise noted.

[Amended on May the 23rd, 2014 to remove unnecessary disclosures.]