DBRS Downgrades RBS to A (low), Negative Trend

DBRS Ratings Limited (DBRS) has today downgraded the Long-Term Debt and Deposit ratings of Royal Bank of Scotland plc (RBS) to A (low) from ‘A’. The Short-Term rating was confirmed at R-1 low (Stable) and the Intrinsic Assessment (IA) downgraded to BBB (high) from A (low). The Long Term ratings of Royal Bank of Scotland Group plc (RBSG or the Group) were downgraded to BBB (high) from A (low) and the Short-Term rating to R-2 high (Negative) from R-1 low. The Trend on all Long-Term debt ratings is Negative.

The downgrade follows the announcement on 27th February of the results of the Group’s Strategic Review, which will entail a further major restructuring of the Group’s cost base and prolongs the Group’s probable recovery point beyond DBRS’ previous expectations. The scope of the plan highlights the challenges of downsizing a group of the size and complexity of RBSG.

The trend on the Group’s Long-Term ratings is Negative, reflecting DBRS’ view that there is a high level of execution risk associated with the plan. Further downward pressure on the ratings could result from a failure to build capital ratios in line with plans or from any indications that the reengineering task is affecting the Group’s position in its core UK retail and commercial banking businesses. Upward pressure on the ratings could arise in the medium-term if the Group successfully executes its wide-ranging cost reduction plan, as well as its accelerated risk reduction/ disposals.

RBSG’s restructuring plan entails a GBP 5.3 billion reduction in the Group’s GBP13 billion cost base. Of this headline number, GBP 3 billion will come from disposals (including Citizens and the EU-mandated branch sale) and asset run-offs (including the capital-intensive assets held in the internal bad bank - RBS Capital Resolution), but the Group will still be targeting a GBP 2.2 billion cost reduction from simplifying processes and re-engineering platforms. The Group is anticipating restructuring charges of GBP 5.2 billion to carry out all the cost reductions (of which, GBP 1 billion had been announced in November), and DBRS expects this to extend the loss-making period of the Group beyond DBRS’ previous expectations.

The plan to dispose/ run off around GBP 190 billion assets is challenging, but DBRS notes that RBSG has built up a strong track record in selling businesses/ reducing Risk Weighted Assets (RWAs). Successful execution of the plan is an essential component of the rebuild of RBSG’s capital ratios, which with an end-point CRD4 Common Equity Tier 1 ratio of 8.6% at end-2013, remain at the low-end of its global peer group.

However, DBRS views the cost programme/ business restructuring as an enormous overhaul with a high level of execution risk. The programme is essential as multiple years of disposals/ asset reductions have meant the Bank’s infrastructure is out of line with the Group’s requirements. In addition, the serious IT failures RBSG has experienced in the past 18 months have also shown that the Group has large investment needs. As a result, RBSG now faces a further full 3- 5 years of restructuring at best – longer than DBRS had incorporated into the previous rating level – and with higher restructuring charges than previously expected.

The ratings remain supported by the strong funding and liquidity position of the Group that is derived from the strength of its core client franchises. Usage of wholesale funding continues to decrease and the Group reported a loan-to-deposit ratio of 94% at end-2013 (100% at end-2012).

Moreover, DBRS notes that RBS still retains extremely strong market shares in its core activities – retail and commercial banking in the UK, and corporate banking/ debt capital markets in Europe. The focus on these activities will increase through the Group’s reorganization into three main businesses: Personal & Business; Commercial & Private Banking; and Corporate & Institutional. Despite the sizeable challenges faced by RBS over the past 5 years, these market shares have largely remained intact. However, DBRS considers that the latest round of restructuring puts the Group at a disadvantage to competitor banks, which do not require the same level of restructuring and have more flexibility with regards to capital.

Notes:
All figures are in British pound (GBP) unless otherwise noted.

The applicable methodologies are the Global Methodology for Rating Banks and Banking Organisations. Other methodologies used include the DBRS Criteria: Support Assessment for Banks and Banking Organisations and DBRS Criteria: Rating Bank Capital Securities – Subordinated, Hybrid, Preferred & Contingent Capital Securities. All can be found on the DBRS website under Methodologies.

The sources of information used for this rating include the company documents and SNL Financial. DBRS considers the information available to it for the purposes of providing this rating was of satisfactory quality.

DBRS does not audit the information it receives in connection with the rating process, and it does not and cannot independently verify that information in every instance.

Generally, the conditions that lead to the assignment of a Negative or Positive Trend are resolved within a twelve month period. DBRS’s outlooks and ratings are under regular surveillance.

For further information on DBRS historic default rates published by the European Securities and Markets Administration (“ESMA”) in a central repository, see:
http://cerep.esma.europa.eu/cerep-web/statistics/defaults.xhtml.

Ratings assigned by DBRS Ratings Limited are subject to EU regulations only.

Lead Analyst: Elisabeth Rudman
Rating Committee Chair: Alan G. Reid
Initial Rating Date: October 27, 2004
Most Recent Rating Update: November 15, 2013

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For additional information on this rating, please refer to the linking document located at: http://www.dbrs.com/research/236983/banks-and-banking-organisations-linking-document.pdf