Will Royal Bank of Scotland Group Reinstate a Dividend?

Advanced talks are ongoing, but what does it mean for shareholders?

Mar 18, 2014 at 11:00AM

Shortly before the financial crisis, Royal Bank of Scotland Group (NYSE:RBS) was the world's largest bank. But by 2009, the institution had required 45 billion pounds of government assistance and became 81% owned by the British government.

Since then, dividends on common shares of RBS have been suspended for political and financial reasons. But news breaking over the weekend suggests RBS may be closer to a dividend than previously thought.

The golden share
The Financial Times is reporting the RBS is in "advanced talks" with the government about repurchasing the "golden share" held by the government. The "golden share" is a dividend enhanced share allowing the government to take dividends before other shareholders are paid.

According to the Financial Times, the "golden share" was worth 1.5 billion pounds as of last March. As of the writing of this article, RBS has delayed its annual meeting and has yet to comment on the "golden share" talks.

What about its peers?
Dividends are seen as one of the foundations of bank stock investing, so it's no surprise that Britain's non-government owned major banks all offer dividends. Barclays (NYSE:BCS) yields around 2.6% while HSBC (NYSE:HSBC) is one of the top dividend bank stocks with an impressive yield of around 5%.

But both Barclays and HSBC are solidly profitable banks without government shareholdings. As such, they are largely able to distribute profits how they want. Lloyds Banking Group (NYSE:LYG) falls in between these two banks and the majority government owned RBS. Lloyds remains 33% owned by the British government, down from 39% following government share sales. The bank has no dividend right now, but is looking to reinstate one within the next few years.

Potential strategy
RBS is far from the position of Lloyds with respect to financial performance and government ownership. However, repurchasing the "golden share" does not necessarily mean the reinstatement of dividends immediately. Rather, RBS may be looking for the flexibility to reinstate the dividend when it determines it's both politically and financially reasonable.

Looking forward, if RBS does begin paying a dividend, I would expect it to take until at least the latter part of 2014, if not into 2015. A number of obstacles still exist for RBS including developing a consistent record of positive earnings, restructuring within the bank, and successful performance in the upcoming European stress tests.

I would also expect the initial dividend from RBS to be more of a cosmetic dividend rather than a source of significant income for shareholders. The style of tiny dividends from banks just to note they have a dividend has a precedent in U.S. based banks such as Bank of America and Citigroup. And with RBS' inconsistent record of profitability over the past several years, starting the dividend out small is probably the best way to go.

What to look for
Repurchasing the "golden share" would grant additional flexibility to RBS in terms of resuming future dividend payments. Investors should continue to monitor how these talks progress to assess the future of RBS.

However, investors should not expect giant dividend payouts as RBS is still working through its own issues and still has obstacles ahead of it. While a reinstatement of the dividend may provide some shorter-term rewards, I still consider RBS as a long-term recovery investment.

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Alexander MacLennan is long January 2015 $20 calls on Bank of America, long Bank of America Class B warrants, long January 2015 $40 calls on Citigroup, long January 2015 $45 calls on Citigroup, and long January 2015 $50 calls on Citigroup . This article is not an endorsement to buy or sell any security and does not constitute professional investment advice. Always do your own due diligence before buying or selling any security. The Motley Fool has no position in any of the stocks mentioned. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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