Is it Safe to Invest in Royal Bank of Scotland Again?

Source: RBS.

Royal Bank of Scotland (NYSE: RBS  ) reported an enormous jump in first-quarter profits last Friday to about $2 billion, a huge improvement over the first quarter of 2013.

Overall, the bank's news sounded great. Costs were reduced 6% year-over-year, net interest margins are up, the bank's Irish subsidiary, Ulster Bank, turned a profit for the first time in five years, and impairments are down 65% from a year ago. The bank's core Tier 1 ratio is up 80 basis points to 9.4%, and its leverage ratio has risen to 3.7%.

So should we be jumping for joy and buying RBS? 

Not so fast
As the bank's executives said themselves, don't read too much into one quarter. Impairments were low in the first quarter -- 114 million pounds -- but are expected to total about 1.5 billion pounds for 2014. This means that this was a light quarter for the bank and not indicative of a new trend. As described on the earnings call, there is still the possibility for volatility ahead.

Similarly, The bank's restructuring costs are expected to climb throughout the year. RBS expects the costs to rise in the second quarter and through the second half of the year, and executives are sticking with their initial guidance that restructuring costs are expected to total about 5 billion pounds over the coming few years.

Of course, RBS intends to get a good return on the restructuring activity starting in the second half of 2014. One quarter of data isn't enough to make any real assessments of how well it's going, though.

The executive team also cautioned that some gains look better because of a low starting point. For example, their markets division had a tough first quarter in 2013, so this year's first quarter looks a lot better by comparison. This is especially true when taking into account once-off additions from deleveraging activities. In reality, the bank's markets division is in the same boat as everyone else's trading divisions: that is to say, down.

Finally, it's possible that RBS could face about $8.4 billion in litigation claims stemming from a 2008 rights issuance. The bank has promised to fight the charges rather than settle, but it could add significantly to the costs facing the bank in 2014.

It's also worth noting that the British public is still about GBP 14 billion underwater on its investment in RBS (the UK government owns 81% of the bank.)

Still, it's not all bad
RBS intends to become a "simpler, smaller, and smarter bank," according to its CEO Ross McEwan. It seems to be going boldly in that direction. The bank has revamped its operations from seven divisions to three, and has already had success in reducing the number of commercial and retail banking products (expected to be cut by half by the end of 2014.)

The bank improved costs by about 6% year over year, including a 10% decline in staff costs with a 6,000 strong fall in headcount. RBS' Citizens Bank in the U.S. has cut costs by 4% from last year.

The smaller and smart strategy might be working. Just five years ago, the investment bank was responsible for 82% of the bank's profits. That number dropped to 20% in 2013, and is expected to keep falling as the bank's restructuring continues.

What next?
In the words of McEwan, there are still a lot of headwinds facing RBS. However, there do appear to be some positive trends at work. Provided that the bank can stick with its strategy, avoid further scandals such as the immense headaches of forex and Libor, and benefit from an expanding British economy, perhaps we will see RBS rise again. 

Big banking's little $20.8 trillion secret
There's a brand-new company that's revolutionizing banking, and is poised to kill the hated traditional brick-and-mortar banks. That's bad for them, but great for investors. And amazingly, despite its rapid growth, this company is still flying under the radar of Wall Street. To learn about about this company, click here to access our new special free report.

Read/Post Comments (0) | Recommend This Article (1)

Comments from our Foolish Readers

Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

Be the first one to comment on this article.

Sponsored Links

Leaked: Apple's Next Smart Device
(Warning, it may shock you)
The secret is out... experts are predicting 458 million of these types of devices will be sold per year. 1 hyper-growth company stands to rake in maximum profit - and it's NOT Apple. Show me Apple's new smart gizmo!

DocumentId: 2952024, ~/Articles/ArticleHandler.aspx, 9/4/2015 7:33:42 PM

Report This Comment

Use this area to report a comment that you believe is in violation of the community guidelines. Our team will review the entry and take any appropriate action.

Sending report...

Anna Wroblewska

Anna began her career in finance as a college intern at a hedge fund, and she hasn’t been able to escape its siren song ever since. She’s done academic research at Harvard Business School and UCLA, was the COO of a wealth management firm, and now writes about finance, economics, behavior, and business.

Today's Market

updated Moments ago Sponsored by:
DOW 16,102.38 -272.38 -1.66%
S&P 500 1,921.22 -29.91 -1.53%
NASD 4,683.92 -49.58 -1.05%

Create My Watchlist

Go to My Watchlist

You don't seem to be following any stocks yet!

Better investing starts with a watchlist. Now you can create a personalized watchlist and get immediate access to the personalized information you need to make successful investing decisions.

Data delayed up to 5 minutes

Related Tickers

9/4/2015 4:01 PM
RBS $9.77 Down -0.35 -3.46%
Royal Bank of Scot… CAPS Rating: **