DBRS Morningstar Confirms The Royal Bank of Scotland Group plc at BBB, Trend Revised to Stable

DBRS Ratings Limited (DBRS Morningstar) 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 BBB (high) Long-Term Issuer Rating. The trend on these ratings was revised to Stable from Positive. RBSG’s Intrinsic Assessment (IA), which reflects the Group’s combined credit strength, has been maintained at BBB (high). The Group’s Support Assessment remains SA3 and its Long-Term Issuer Rating is positioned one notch below the IA, in line with DBRS Morningstar’s approach to rating bank holding companies. RBSG’s short term ratings were upgraded to R-2 (high) as a result of applying the short term rating exception, aligning the approach with the typical mapping of short term ratings for bank holding companies. Please see a full list of the rating actions at the end of this press release.

KEY RATING CONSIDERATIONS

The change of the trend to back to Stable reflects our view that RBSG’s risk profile and earnings generation are likely to be adversely affected by a major economic slowdown, driven by the Covid-19 pandemic, and that this will reverse the upward pressure on the ratings. The impact is likely to emerge in the coming quarters, whilst the implications for the medium to long-term will depend on the depth of the economic crisis. DBRS Morningstar also notes the uncertainty around the terms of UK’s departure from the EU, which, in case of a disorderly exit, could lead to a further deterioration in macroeconomic conditions. We expect the impact of the economic downturn to be in part offset by the Group’s business-line diversification, conservative lending, and strengthened capital position, as well as the positive impact of some of the support measures announced by the UK government and central banks.

RBSG’s BBB (high) IA incorporates its position as one of the largest UK banking groups with a strong retail and commercial banking franchise and a leading position in the domestic market. It also reflects the ongoing focus on cost-efficiency, improved asset quality and the robust funding and liquidity profile. The Group de-risked and strengthened its balance sheet in recent years and its present capital ratios compare favourably with those of many domestic and European peers.

RATING DRIVERS

Given the revision of the trend to Stable from Positive, a rating upgrade is unlikely in the near term. However, the ratings could be upgraded if the Group’s credit profile remains resilient throughout the economic downturn driven by the Covid-19 pandemic, while, in the medium term, profitability and credit risk metrics return to an improvement trend observed in recent years.

A severe deterioration in the Group’s asset quality and profitability, as a result of the economic shock resulting from the Covid-19 pandemic could lead to a rating downgrade. This could also be driven by a Brexit outcome that materially diminishes the UK’s economic resilience and leads to a major deterioration in RBSG’s credit profile. Any sign of weakening in the Group’s franchise, following a long period of intense restructuring and business exits could result in a downgrade.

RATING RATIONALE

RBSG is one of the largest UK banking groups with a strong retail and commercial banking franchise. Its core segments include UK Personal Banking, serving personal and premier segments in the UK, and Commercial Banking, which caters to SME, corporate, and commercial customers. NatWest Markets provides financing and risk management to corporate customers and financial institutions.

Following a multi-year period of annual losses, RBSG returned to profitability in 2017, however in 2020 earnings have come under pressure from the impact of the Covid-19 outbreak. In Q1 2020 RBSG's statutory profit before tax was GBP 519 million, declining by 49% YoY, due to the Covid-19 pandemic leading to a significant increase in the cost of risk.. Revenues were GBP 3.2 billion, up 4% YoY, boosted by strong performance in NatWest Markets where income more than doubled YoY. Overall, operating expenses remained under good control, declining by 5% to GBP 1.8 billion. In 2019, the Group’s profit attributable to ordinary shareholders was GBP 3.1 billion, up 93% year-on-year (YoY). The improvement was driven by one-off notable items, which included a GBP 1.8 billion gain on the Alawwal bank merger and subsequent liquidation of RFS Holdings B.V., and GBP 0.9 billion in PPI charges.

In recent years RBSG has consistently improved its risk profile, disposing of legacy loans and increasing its UK lending, which has a relatively low share of impaired exposures. This improvement continued in 2019 and the share of Stage 3 exposures (assets, which have defaulted or are otherwise considered to be credit impaired) declined to 1.9%, down from 2.6% a year earlier. During Q1 2020, as a result of increased provisioning due to the Covid-19 pandemic, RBSG increased the provision coverage of its loan book to 1.2% from 1.1%. In 2019 conduct and litigation costs were GBP 0.9 billion, consisting mainly of PPI provisions. Following the August 2019 industry deadline for PPI claims, we expect the drag from litigation and conduct on RBSG' earnings to diminish substantially from 2020.

RBSG maintains a robust funding and liquidity position. Customer deposits represent the main funding source for the Group. At end-2019, customer deposits totalled GBP 369 billion, representing 79% of the Group’s total non-equity funding excluding repos, based on DBRS Morningstar calculations. The Group’s loan-to-deposit ratio was well positioned at 91% at end-1Q 2020. The Group had a substantial liquidity buffer of GBP 201 billion at end-Q1 2020. Within this, primary liquidity was GBP 134 billion. The Liquidity Coverage Ratio was a strong 152% and the Net Stable Funding Ratio was 138% at end-Q1 2020.

RBSG's capital levels compare favourably with those of many domestic and European peers and this positions the Group relatively well to deal with a significant economic downturn expected as a result of the Covid-19 pandemic. At end-2019 the Group's Common Equity Tier 1 (CET1) ratio was 16.2%. In Q1 2020, the CET1 ratio increased to 16.6% due to the positive impact of dividend cancelation, in part offset by RWA growth, and remained well above the total capital requirement of 11.4% as set by the PRA. With its Q1 2020 results, the Group maintained its guidance of CET1 ratio of approximately 14% at end-2021 and a reduction to 13-14% in the medium to long term. The end-Q1 2020 UK leverage ratio was a strong 5.8%. With loss absorbing capital on a transitional basis estimated at 34.1% of RWAs, the Group is well placed to meet the expected MREL requirements of 25.3% from 2022.

Concurrently, DBRS Morningstar discontinued NatWest N.V.’s Subordinated Debt Rating for business reasons.

ESG CONSIDERATIONS

A description of how DBRS Morningstar considers ESG factors within the DBRS Morningstar analytical framework and its methodologies can be found at: https://www.dbrsmorningstar.com/research/357792.

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

Notes:
All figures are in GBP unless otherwise noted.

The principal methodology is the Global Methodology for Rating Banks and Banking Organisations (11 June 2019). https://www.dbrsmorningstar.com/research/346375/global-methodology-for-rating-banks-and-banking-organisations

For more information regarding rating methodologies and Coronavirus Disease (COVID-19), please see the following DBRS Morningstar press release: https://www.dbrsmorningstar.com/research/357883

The sources of information used for this rating include Company Documents, The Royal Bank of Scotland Group plc
Annual Report and Accounts 2019, The Royal Bank of Scotland Group plc Q1 2020 Interim Management Statement, S&P Global Market Intelligence, Bank of England, HM Treasury, and IMF. DBRS Morningstar considers the information available to it for the purposes of providing this rating to be of satisfactory quality.

This is an unsolicited rating. This credit rating was not initiated at the request of the issuer.

With Rated Entity or Related Third-Party Participation: YES
With Access to Internal Documents: NO
With Access to Management: NO

DBRS Morningstar 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 Morningstar’s outlooks and ratings are under regular surveillance.

For further information on DBRS Morningstar 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.

The sensitivity analysis of the relevant key rating assumptions can be found at:
http://dbrsmorningstar.com/research/361890

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

Lead Analyst: Tomasz Walkowicz, Vice President, Global FIG
Rating Committee Chair: Elisabeth Rudman, Managing Director, Global Financial Institutions Group
Initial Rating Date: October 27, 2004
Last Rating Date: June 17, 2019

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