Questor share tip: Sell RBS on Scotland independence vote

Royal Bank of Scotland
342.2p-2p
Questor says SELL

SHARES in Royal Bank of Scotland [LON:RBS] have fallen by more than 5pc during the past two weeks as investors take fright over Scottish independence.

RBS said in its half-year results that independence could “significantly impact the group’s costs and would have a material adverse effect on the group’s business, financial condition, results of operations and prospects”.

The Edinburgh-based bank, which is 80pc owned by the taxpayer, at the very least would face additional legal and administrative costs to deal with the complex issues of being based in Scotland but providing mortgages and bank accounts to UK customers.

The profitability at RBS would also take a hit from any downgrade in the credit rating. RBS needs to seek funding from debt markets every day and investors may be unwilling to fund RBS so cheaply with independence raising question marks over the capital situation and depositor base of the bank. During the past week the cost of insurance on RBS debt has sharply increased.

Aside from the rather large issue of Scottish independence, which is ultimately outside of the bank’s control, there are also many industry specific challenges facing RBS. The two biggest costs which confront the bank are restructuring, as it sells off trading and investment banking activities, and fines for misselling mortgages and other financial products.

RBS has incurred about £7.3bn in costs to try to sort out the bank since the financial crisis in 2008. In its last half year results, the bank said it expects the total for restructuring charges will be about £5.2bn during the next three years.

The other issue is litigation and compensation claims related to misselling products and interest rate market manipulation. RBS’s most recent provision to deal with all these costs was £3.7bn at the end of June 30. Analysts from Investec expect another £3.6bn on top of that during the next three years but that could rise to £7bn, according to worst-case scenario estimates from other banking analysts.

The problem for RBS is that both those numbers are uncertain and could rise higher and they could be incurred at unpredictable times within the next three years. Analysts from Investec believe that the combined impact of sorting out the bank and paying fines will return RBS to modest losses in the second half of this year and next year.

There is some good news on the horizon, though, as it plans to raise cash by floating its US retail bank Citizens Financial Group. The stock market filing placed a price range of $23 to $25 per share, which implies a value of about $13.4bn for the whole company. RBS is only selling a 25pc stake in Citizens, with a view to selling down more in the future.

RBS is also looking at selling the international operations of Coutts, its private banking business, which handles the banking affairs of the Queen.

Coutts private banking arm most recently reported £28.7bn in assets under management and it is believed the international unit is responsible for 41pc of those assets.The sale could raise between $720m (£430m) and $1.1bn, based on a value of up to 4pc of assets under management.

Despite raising some cash, Questor thinks there is little value in UK banks long term. The UK mortgage market is low growth and that means the majority of RBS’s business is growing very slowly

The valuation looks too high. At around 342p RBS shares are trading at about a 10pc discount to net asset value at 376p but that discount should be larger, given the challenges.

RBS is also exposed to an interest rate shock to its book of mortgages. Finally, a return to meaningful dividends looks a long way off. Questor would sell now.

Watch Questors analysis of what you should do with your shares in Scottish-based firms: