DBRS Confirms The Royal Bank of Scotland Group plc at BBB, Trend Changed to Positive

DBRS Ratings Limited (DBRS) confirmed the ratings of The Royal Bank of Scotland Group plc (RBSG or the Group) and its related entities, including the Group’s ‘BBB’ Long-Term Issuer Rating, and NatWest Markets Plc’s and NatWest Markets N.V.’s BBB (high) Long-Term Issuer Ratings. The trend on these ratings was revised to Positive, along with RBSG’s Short-Term ratings. RBSG’s Intrinsic Assessment (IA), which reflects the Group’s combined credit strength, has been maintained at BBB (high). The Support Assessment of the Group remains SA3 and its Long-Term Issuer Rating is positioned one notch below the Group’s IA, in line with DBRS’s approach to rating bank holding companies. Please see a full list of the rating actions at the end of this press release.

KEY RATING CONSIDERATIONS
The change in the trend to Positive from Stable reflects RBSG’s improved profitability, evidenced in the second consecutive annual bottom line profit generated in 2018. Over the last two years the drag on statutory earnings from legacy conduct issues and strategic costs declined substantially, which combined with resilient underlying performance led to an improvement in earnings.

RBSG’s BBB (high) IA incorporates its position as one of the largest UK banking groups with a strong retail and commercial banking franchise, where, despite the Group’s long restructuring period, RBSG remains one of the market leaders. It also reflects the ongoing focus on cost-efficiency, improved asset quality and the robust funding and liquidity profile. The Group’s capital ratios compare favourably with many European peers and the resolution of the main legacy litigation issues has significantly reduced uncertainty with regards to the Group’s capital position.

RATING DRIVERS
Further upward pressure on the ratings is likely if the Group continues to improve its profitability while maintaining its sound asset quality.

Negative pressure could arise from a material deterioration in asset quality or a higher than expected drag from litigation and conduct. A substantial negative impact of the UK’s exit from the EU on the Group’s risk profile could also exert downward pressure on the ratings.

RATING RATIONALE
RBSG is one of the largest UK banking groups with a strong retail and commercial banking franchise, and through Ulster Bank RoI it is also one of the largest banks in Ireland. At end-1Q19 RBSG’s total assets were GBP 719 billion.

RBSG returned to profitability in 2017 and in 2018 the Group’s earnings strengthened further with profit attributable to ordinary shareholders more than doubling year-on-year (YoY) to GBP 1,622 million, primarily reflecting an increase in total income and lower operating expenses. Statutory income increased by 2% YoY, mainly driven by lower NatWest Markets legacy disposal losses. However, excluding notable items, total income was down 5% due to lower NatWest Markets income and reduced net interest income. Operating costs decreased by 7% on the back of lower strategic costs and a decline in other expenses. Earnings remained impacted by conduct and litigation charges, at GBP 1.3 billion, mainly reflecting the incremental provisions related to the settlement with the US Department of Justice (DoJ) in relation to RBSG’s legacy residential mortgage-backed securities (RMBS) activities. The Group remains focused on improving its cost efficiency. During 2018 headcount fell by 6% YoY and operating expenses, adjusted for litigation and conduct, strategic costs and other exceptionals, were down by 3.6%. In 1Q19 RBSG’s attributable profit to ordinary shareholders was GBP 707 million, down from GBP 808 million in 1Q18.

While strategic costs are likely to remain significant in 2019, charges related to the remaining legacy issues should be of a substantially lesser magnitude than in the past. This reflects that the Group has now resolved the major legacy issues and it remains focused on putting in place and maintaining measures to prevent future issues related to conduct. The Group aims to further improve its profitability in the medium term, targeting a return on tangible equity of more than 12% in 2020, compared to 4.8% in 2018.

In recent years RBSG’s credit risk profile has benefitted from a steady flow of disposals of legacy loans and a growing concentration on UK lending, which has a relatively low share of impaired exposures. The Group’s asset quality ratio has stabilised over the last year and the share of Stage 3 exposures under IFRS 9 (assets, which have defaulted or are otherwise considered to be credit impaired) was 2.4% at FY18. DBRS notes that the UK’s departure from the EU could potentially lead to a deterioration in UK macroeconomic conditions, which could have a significant impact on the Group’s UK and Irish operations. However, DBRS would expect its impact to be mitigated by the Group’s conservative underwriting standards and a low risk mortgage book.

RBSG maintains a robust funding and liquidity position. Customer deposits represent the main funding source for the Group, representing 83% of the Group’s total funding excluding repos, based on DBRS calculations. At FY18 the Group had a substantial liquidity buffer of GBP 198 billion, of which primary liquidity was GBP 128 billion. The Net Stable Funding Ratio (NSFR) was 141% at FY18 and the Liquidity Coverage Ratio (LCR) was a strong 158%.

The settlement with the DoJ removed significant uncertainty, improving DBRS’s view of the Group’s capital position. The Group reported a fully-loaded Common Equity Tier 1 (CET1) ratio of 16.2% at end-1Q19, stable quarter-on-quarter (QoQ), following a 0.3% increase during 2018. In 2018 the CET1 ratio strengthened as in 2018 the Group generated a second consecutive annual profit and continued to reduce risk-weighted assets (RWAs), more than offsetting the impact of the accelerated pension deficit contribution, the RMBS settlement and the dividend. The Group’s capital ratios compare favourably with those of many European peers. DBRS also notes the improved performance of the Group in the BoE’s 2018 stress tests. With Loss Absorbing Capacity on a transitional basis estimated at 30.7% of RWAs at end-2018, an increase from 27.1% at end-2017, RBSG is also well placed to meet the future MREL requirements.

The Grid Summary Grades for The Royal Bank of Scotland Group plc are as follows: Franchise Strength – Strong/Good; Earnings – Moderate; Risk Profile – Good; Funding & Liquidity – Strong; Capitalisation – Good/Moderate.

Notes:
All figures are in GBP unless otherwise noted.

The principal applicable methodology is the Global Methodology for Rating Banks and Banking Organisations (June 2019). This can be found can be found at: http://www.dbrs.com/about/methodologies.

The sources of information used for this rating include SNL Financial, Bank of England, European Banking Authority and company documents. DBRS considers the information available to it for the purposes of providing this rating to be 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 historical default rates published by the European Securities and Markets Authority (“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 and US regulations only.

Lead Analyst: Tomasz Walkowicz, Vice President, Global Financial Institutions
Rating Committee Chair: Ross Abercromby, Managing Director, Global Financial Institutions
Initial Rating Date: October 27, 2004
Last Rating Date: June 18, 2018

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