A report in the Financial Times on Monday suggested that the government’s accounting rules will require it to write down the value of its 73% stake in Royal Bank of Scotland Group (LSE: RBS) from £21.5bn to £14.7bn in the Chancellor’s Autumn Statement.
It would be the second such writedown in six months, and reflects the 42% decline in the bank’s share price so far this year. Today’s 175p share price is 65% lower than the 503p paid by the government back in 2008, when it saved RBS with a £45bn bailout.
Yet despite all the bad news, RBS has made some progress since 2008. Could now be the right time for contrarian investors to start taking an interest in the group?
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Why would anyone buy?
RBS has been a disastrous investment since the financial crisis. But at some point the shares will become cheap enough to offer good value — assuming the bank doesn’t end up failing altogether.
There are some signs of hope. RBS reported a Common Equity Tier 1 ratio of 14.5% at the end of June. That’s well above the regulatory threshold and higher than most of the UK’s other big banks.
RBS shares also trade at a discount of 50% to their tangible net asset value of 345p. The latest broker forecasts suggest that the bank will report adjusted earnings of 12.8p per share in 2016 and 16.3p per share in 2017. These give RBS a forecast P/E of 13.3, falling to 10.4 next year.
On paper, RBS does have some of the qualifications needed for a value stock.
Here’s the problem
The trouble is that the bank’s book value and earnings forecasts keep on falling. For example, consensus forecasts in October 2015 suggested that RBS would report adjusted earnings of 24.8p for 2016. That forecast has since halved to just 12.8p.
Even if RBS starts to deliver reliable profits, these figures only represent adjusted earnings. The gap between the bank’s adjusted profits and its reported losses is huge.
During the first half of 2016, RBS reported an adjusted profit for its core operating divisions of £5,801m. But the group’s statutory accounts showed that it made an overall loss of £2,045m.
It’s hard to know which figures — if any — should be used to value RBS.
Two key hurdles
One of the most urgent problems facing chief executive Ross McEwan is the divestment of the bank’s Williams & Glyn subsidiary. The bank was meant to commit to a firm plan in 2016 as part of the terms of its bailout.
But RBS shelved a planned flotation in August and has yet to find a trade buyer for these assets. It’s not know what sanctions, if any, RBS might face if it fails to do a deal this year.
A second problem is that RBS is the subject of several US investigations into alleged mis-selling of mortgage securities. These are expected to result in multi-billion dollar payouts. The bank warned earlier this year that further provisions might be necessary to meet these costs.
Once these issues have been resolved, then it may be worth taking a fresh look at RBS. But in my view the shares are only suitable for very brave or expert investors at the moment.
