The Royal Bank of Scotland Group plc

Transcription

1 CREDIT OPINION 11 April 218 The Royal Bank of Scotland Group plc Post rating action update Update Summary Rating Rationale On 4 April 218, we assigned a notional group Baseline Credit Assessment (BCA) of to The Royal Bank of Scotland Group plc (RBSG) and affirmed all its ratings, including its longterm senior unsecured debt ratings at Baa3 long-term and Prime-3 short-term. RATINGS The Royal Bank of Scotland Group plc Domicile United Kingdom Long Term Debt Baa3 Type Senior Unsecured - Fgn Curr Outlook Stable Long Term Deposit Not Assigned Please see the ratings section at the end of this report for more information. The ratings and outlook shown reflect information as of the publication date. The BCA of RBSG reflects: (1) its strong capital and litigation reserves levels which should allow the bank to absorb the resolution of pending RMBS litigations without detriment to the bank s overall solvency, (2) sustainable earnings from core retail and corporate businesses, which will help to mitigate downward credit pressures due to the weakening UK operating environment in the period leading up to Brexit and provide substantial shock absorbers relative to the remaining capital markets business and (3) substantially reduced non-core assets and reduced exposure to more volatile and complex capital markets risks and earnings and improved risk framework and governance. Exhibit 1 Rating Scorecard - Key Financial Ratios1 Exhibit 2 Contacts RBS (BCA: ) 45% 18% 4% 18.5% Alessandro Roccati Senior Vice President alessandro.roccati@moodys.com Solvency Factors 16% Laurie Mayers Associate Managing Director laurie.mayers@moodys.com Americas Asia Pacific Japan EMEA % 14% 25% 1% 2% 2 8% 15% 6% 4% 35% 3% 12% 1%.78% 5% 2%.2% % Asset Risk: Problem Loans/ Gross Loans Capital: Tangible Common Equity/Risk-Weighted Assets Solvency Factors (LHS) CLIENT SERVICES Median -rated banks 2% Source: Moody's Banking Financial Metrics Profitability: Net Income/ Tangible Assets % Funding Structure: Market Funds/ Tangible Banking Assets Liquid Resources: Liquid Banking Assets/Tangible Banking Assets Liquidity Factors (RHS) Liquidity Factors Nick Hill MD-Banking nick.hill@moodys.com

2 Credit Strengths» Capitalization continues to improve as deleveraging progresses but remains vulnerable to short-term shocks» Sizeable shock-absorbers provided by retail and commercial banking activities continue to be eroded by ongoing conduct, litigation and restructuring costs» Liquidity and funding are currently sound» Moderate volume of senior unsecured debt, resulting in no loss-given failure uplift from the BCA» Low probability of government support resulting in no uplift incorporated in its senior unsecured debt ratings Credit Challenges» Ambitious and complex overall restructuring is well advanced but continues to pose short-term risks to bondholders» Credit risk, despite large improvements, is weaker than peers and capital markets activities, although reduced, remain sizeable Rating Outlook RBSG s senior unsecured debt ratings carry a stable outlook. The stable outlook reflects our expectation that fundamentals will stabilize over the next eighteen months as the non-core unit will further wind-down and RBSG substantially completes its restructuring exercise enabling the group to generate more stable and sustainable earnings. Factors that Could Lead to an Upgrade» An upgrade of RBSG's ratings could occur if the bank were to return to sustainable profitability in line with that of peers, generate capital organically and successfully complete its multi-year restructuring exercise. Factors that Could Lead to a Downgrade» The ratings of RBSG could be downgraded if the group's restructuring and de-risking strategy fails to deliver improvements in its credit fundamentals, weakening its capital, profitability and operational efficiency levels and raising its asset risk. A significant deterioration in the operating environment beyond our base case expectations, and/or regulatory and litigation charges that are substantially higher than those we currently expect, may also result in a downgrade of the BCA.» The ratings could also be downgraded as a result of a sizeable reduction in the outstanding liabilities that could be bailed in, resulting in a higher loss-given-failure for senior creditors and hence a lower rating. This publication does not announce a credit rating action. For any credit ratings referenced in this publication, please see the ratings tab on the issuer/entity page on for the most updated credit rating action information and rating history April 218

3 Key indicators Exhibit 3 The Royal Bank of Scotland Group plc (Consolidated Financials) [1] Total Assets (GBP billion) Total Assets (EUR billion) Total Assets (USD billion) Tangible Common Equity (GBP billion) Tangible Common Equity (EUR billion) Tangible Common Equity (USD billion) Problem Loans / Gross Loans (%) Tangible Common Equity / Risk Weighted Assets (%) Problem Loans / (Tangible Common Equity + Loan Loss Reserve) (%) Net Interest Margin (%) PPI / Average RWA (%) Net Income / Tangible Assets (%) Cost / Income Ratio (%) Market Funds / Tangible Banking Assets (%) Liquid Banking Assets / Tangible Banking Assets (%) Gross Loans / Due to Customers (%) , CAGR/Avg , [1] All figures and ratios are adjusted using Moody's standard adjustments [2] Basel III - fully-loaded or transitional phase-in; IFRS [3] May include rounding differences due to scale of reported amounts [4] Compound Annual Growth Rate (%) based on time period presented for the latest accounting regime [5] Simple average of periods presented for the latest accounting regime. [6] Simple average of Basel III periods presented Source: Moody's Financial Metrics Detailed Credit Considerations Ambitious and complex restructuring is well advanced but continues to pose short-term risks to bondholders RBSG has continued to advance the complex restructuring of its operations, which comprises a number of initiatives that will change its business mix, reduce its risk profile, and improve operational efficiency levels. The group has undertaken a multi-year restructuring programme of all of its core operations, consisting of : (1) leveraging on its core Personal and Business Banking and Commercial and Private Banking businesses in the UK and in Ireland; (2) downsizing its NatWest Markets' capital markets operations by further reducing the corresponding risk-weighted assets (RWAs) of 52.9 billion at end-217. Management targets a return on tangible equity of above 12%, a cost to income ratio of below 5% by 22 and a common equity Tier 1 in excess of 13% in the short to medium term. We view this ongoing initiative as positive for the bank's creditors because, if executed according to plan, it will reduce the group's overall risk profile and simplify its operations, make the bank more efficient and restore its profitability, materially strengthen its solvency and further improve the bank's asset-risk profile. Credit risk, despite large improvements, is weaker than peers and capital markets activities, although reduced, remain sizeable RBSG's operating environment is heavily influenced by the UK and its Macro Profile is currently Strong+. UK banks benefit from operating in a wealthy and developed country with a very high degree of economic, institutional and government financial strength as well as a low susceptibility to event risk. The main risks to the system now stem from the economic uncertainty resulting from the UK s decision to leave the European Union (EU) and the high level of indebtedness of UK households, which are sensitive to changes in interest rates. UK banks are largely funded by deposits and banks' funding structures have remained relatively stable in the past few years, with slight increases in capital as well as declines in short-term funding. RBSG's credit risk profile has materially improved as a result of a reduction in problem loans and the disposal of non-core assets. Problem loans (RBSG's internal definition) as a proportion of gross loans decreased to 2.7% at end-217 from 3.1% at end-216 and 3.9% at end-215 (Exhibit 3) April 218

4 Legacy RWAs decreased to around 23 billion at end-217, representing around 11% of group RWAs: 2.6 billion legacy RWAs at NatWest Markets (of which 7 billion relate to Alawwal Bank (LT deposits rating A3)) and 2.1 billion shipping legacy RWAs in the Commercial Banking division. We expect this positive trend to continue as the bank progresses towards the completion of the non-core asset run-off and delivers further material reduction in risk. Exhibit 4 Credit quality is steadily improving RBS: quarterly NPL ratio (RBS definition Risk Elements In Lending (REIL) / gross loans) Group Risk Elements in Lending (REIL) % Gross Loans 5.% Core divisions Risk Elements in Lending (REIL) % Gross Loans 4.5% 4.5% 3.9% 4.% 3.5% 3.8% 3.6% 3.2% 3.% 3.5% 3.2% 3.% 3.1% 3.% 3.1% 2.9% 2.5% 2.5% 2.8% 2.4% 2.7% 2.4% 2.7% 2.3% 2.% 1.5% 1.%.5%.% Sep5 Dec5 Mar6 Jun6 Sep6 Dec6 Mar7 Jun7 Sep7 Dec7 Source: RBS Group's Annual Report and Interim Management Statements RBSG retains a decreased but still large presence in global capital markets through NatWest Markets reflecting the group s objective of maintaining investment banking capabilities to support its corporate, financial institution and central bank clients. RWA allocated to NatWest Markets (including 2.6 billion legacy RWAs) were 52.9 billion at end-217 (around one fourth of group total). Further reduction in capital markets activities would be positive for the group credit profile because revenues from these activities are inherently volatile, as they largely depend on market conditions, and more confidence sensitive. The high degree of volatility of capital markets revenues and inherent although decreasing risks carried by this type of activity as well as the complexity of RBSG s multi-year restructuring program currently constrains the credit profile of RBSG and are reflected in a one-notch negative adjustment for opacity and complexity, in the qualitative section of our BCA scorecard. Our assigned Asset Risk score of baa2 reflects both the good improvement RBSG has achieved in credit quality but also takes into account the still high level of operational risk associated with the execution of its restructuring, including structural reform, as well as market, counterparty and operational risk that is carried by capital markets activities. Capitalization continues to improve as deleveraging progresses but remains vulnerable to short-term shocks RBSG shows one of the highest capital ratios among domestic and international peers: it reported a fully-applied Common Equity Tier 1 (CET1) ratio of 15.9% at end-217 (exhibit 4). The group expects to be required to meet a CET1 requirement of 11.1% (4.5% plus a 2.1% Pillar 2A add-on plus UK countercyclical capital buffer of 1.% as well as conservation buffer of 2.5% and a GSIB buffer of 1.%) at 1 January 219. RBSG reported a CRR leverage ratio of 5.3% and a UK leverage ratio of 6.1% at end-217, which is well above the UK Prudential Regulation Authority's current 3.25% requirement. Management targets a CET1 ratio in excess of 13% after the settlement of large pending litigations and the remaining budgeted restructuring costs. We believe that this target is achievable, although capital remains vulnerable to short-term shocks, such as additional charges which may occur as RBSG resolves its US retail-mortgage security (RMBS) litigation with the US Department of Justice (DOJ) for the mis-selling of US residential mortgage backed securities (RMBS) between 24 and 27. We estimate that existing provisions would be sufficient to cover a median scenario settlement ($3.5 billion) with the US DOJ and that a high-end settlement ($8.8 billion) would lead to a 3.5 billion net additional litigation charge, which would decrease RBSG CET1 ratio by around 17 basis points April 218

5 Longer-term, RBSG s capital position will benefit from a lower amount of capital allocated to capital markets, the active workout of the legacy asset assets, and additional improvements in asset risk. Regulatory inflation due to proposed Basel III changes and the impact of low for longer rates on its pension liabilities and assets will, however, offset some of the benefits. Exhibit 5 Capital has improved substantially while leverage remains adequate RBS s reported and targeted CET1 ratio (end-point) and Basel III leverage ratio CET1 ratio, end-point* 18.% 16.% 3.1 billion RMBS 15.% provision increase 13.4% 14.5% 14.6% 14.% Leverage ratio, end-point* 15.9% 15.5% 14.8% 14.1% 12.% 1.% 8.% 6.% 5.3% 5.6% 5.2% 5.1% 5.% 5.1% 5.3% 5.3% 4.% 2.%.% Mar6 Jun6 Sep6 Dec6 Mar7 Jun7 Sep7 Dec7 Source: RBS s quarterly Interim Management Statements, Moody's RBSG expects its total loss absorbing capital requirement (MREL) to be around 27.8% of RWAs (including capital buffers) on 1 January 222 (end-state). The MREL estimates are based on illustrative 222 RWAs of 21 billion. We assign a capital score of a3, reflecting the potential volatility that the group's capital ratios could still experience and our view that RBSG's financial flexibility to absorb unexpected losses through the issuance of new equity is somewhat constrained by its quasi ownership by the UK government (Aa2 stable). Sizeable shock absorbers provided by retail and commercial bank activities continue to be eroded by ongoing conduct, litigation and restructuring charges RBSG maintains a leading position in the UK financial services market, where it mainly operates under the RBS and the NatWest brands. The group also has a relatively small but profitable UK-based wealth management business (Coutts, unrated). Retail and commercial activities continue to provide good underlying shock absorbers against the potential earnings volatility stemming from the bank's capital markets activities, litigation settlements, restructuring costs and the operational risk and costs related to regulatory investigations and IT breakdowns. In 217, the group reported 752 million net attributable profit for the year, the first yearly profit in ten years, equal to a Return on Tangible Equity of around 2% and a return on assets of around.1%. Adjusted income2 increased 4.% year-on-year; adjusted operating costs3 reduced by 81 million or 9.6%. The bank recorded 1.3 billion litigation and conduct costs and 1.6 billion restructuring costs. We expect RBSG's profitability to continue to be negatively impacted by elevated restructuring costs and the charges related to the settlement of residual litigations. Management budgets 2.8 billion of restructuring charges in 218, well-above the previous target of 1 billion (excluding Williams & Glyn) due to IT and real estate related costs. Litigation and conduct costs could be elevated in 218: we estimate the charge related to the settlement of the RMBS litigation with the US DoJ could range billion. We expect moderate pressure on revenues, cost of credit and profitability metrics due to Brexit: we view that the period leading up to Brexit will result in heightened uncertainty over the UK s future trade relationship with the EU, leading to lower economic growth, reduced demand for credit, a modest increase in unemployment, downward pressure on property prices and potentially higher and more volatile wholesale funding costs. We assign a b3 score for Profitability, reflecting ongoing profitability pressures April 218

6 Liquidity and funding are currently sound RBSG has sound liquidity and funding positions, as reflected in the a3 Combined Liquidity Score. However, in line with other capital market participants, the bank has large, albeit reducing, wholesale (secured and unsecured) funding requirements, which increase the institution's sensitivity to market confidence. In recent quarters, RBSG continued to reduce its reliance on wholesale funding with a funded balance sheet of 577 billion at end217 ( 552 billion at end-216). In addition, the group's wholesale funding stock of 7 billion at end-217 was more than fully covered by the liquidity buffer of 186 billion at the same date, indicating a much stronger liquidity position than many of its European peers. At end-217, RBSG reported a Basel III Net Stable Funding Ratio (NSFR) of 132% and a Liquidity Coverage Ratio (LCR) of 152%. Our assigned BCA of incorporates a one-notch negative (qualitative) adjustment for Opacity and Complexity, from the firm's baa2 Financial Profile. Notching Considerations Loss Given Failure We apply our advanced Loss Given Failure (LGF) analysis to RBSG because it is domiciled in the UK, which we consider as an operational resolution regime, following the implementation of the EU Bank Resolution and Recovery Directive (BRRD). Our standard assumptions assume: (1) residual tangible common equity at failure of 3% of tangible banking assets, (2) losses post-failure of 8% of tangible banking assets, (3) junior wholesale deposits accounting for 26% of the bank's total deposit book, (4) a 25% run-off in junior wholesale deposits, (5) a 5% run-off in preferred deposits, and (6) a 25% probability of deposits being preferred to senior unsecured debt. For RBSG's senior unsecured debt, our LGF analysis shows a moderate loss-given-failure resulting from the combination of its own volume and the amount of debt subordinated to it. This results in no notching uplift from RBS's BCA. For RBSG's junior securities, our LGF analysis confirms a high level loss-given-failure, given the small volume of debt and limited protection from more subordinated instruments and residual equity. We also incorporate additional notching for junior subordinated and preference share instruments reflecting coupon suspension risk ahead of failure. Government Support For RBSG's senior unsecured debt, we consider the probability of government support from the UK government (Aa2 stable) to be low and therefore we do not include uplift for systemic support. This is because government support, if needed, would only be likely to be provided to the operating entities, in order to enable them to maintain critical functions and mitigate risks to financial stability, from their failure April 218

7 Rating methodology and scorecard factors Exhibit 6 The Royal Bank of Scotland Group plc Macro Factors Weighted Macro Profile Strong + Factor Historic Macro Ratio Adjusted Score Credit Trend Assigned Score Key driver #1 Key driver #2 Solvency Asset Risk Problem Loans / Gross Loans a3 baa2 Operational risk Expected trend Capital TCE / RWA 19.3% aa2 a3 Expected trend Access to capital Profitability Net Income / Tangible Assets.% b3 b3 Expected trend Combined Solvency Score Liquidity Funding Structure Market Funds / Tangible Banking Assets 2 Liquid Resources Liquid Banking Assets / Tangible Banking Assets baa1 39.9% baa1 a1 Combined Liquidity Score Financial Profile Business Diversification Opacity and Complexity Corporate Behavior Total Qualitative Adjustments Sovereign or Affiliate constraint: Scorecard Calculated BCA range Assigned BCA Affiliate Support notching Adjusted BCA a3 Balance Sheet in-scope (GBP million) 168,49 34, ,171 79,114 11,859 7,926 1, ,832 7, ,567 15, ,718 Other liabilities Deposits Preferred deposits Junior Deposits Senior unsecured bank debt Dated subordinated bank debt Junior subordinated bank debt Preference shares (bank) Senior unsecured holding company debt Dated subordinated holding company debt Junior subordinated holding company debt Preference shares (holding company) Equity Total Tangible Banking Assets 7 1% 11 April 218 baa1 Term structure Expected trend at-failure (GBP million) 199,86 273, ,912 59,336 11,859 7,926 1, ,832 7, ,567 15, ,718 % at-failure a1 a3 baa2 Aa2 baa2-ba1 % in-scope 31.8% 57.7% 42.7% 15.% 2.2% 1.5%.2%.1% 1.3% 1.3%.2%.7% 3.% 1% 37.7% 51.8% 4.5% 11.2% 2.2% 1.5%.2%.1% 1.3% 1.3%.2%.7% 3.% 1%

8 Debt class De Jure waterfall De Facto waterfall Notching LGF Assigned Additional Preliminary LGF notching Rating Instrument Sub- Instrument SubDe Jure De Facto Notching Guidance notching Assessment volume + ordination volume + ordination vs. subordination subordination Adjusted BCA Senior unsecured holding company debt 8.2% 7.% 8.2% 7.% Dated subordinated holding company 7.% 4.1% 7.% 4.1% ba1 debt Junior subordinated holding company 4.1% 4.1% ba2 (hyb) debt Holding company cumulative preference 3.% 3.% -2 ba3 shares Holding company non-cumulative 3.% 3.% -2 ba3 (hyb) preference shares Instrument class Senior unsecured holding company debt Dated subordinated holding company debt Junior subordinated holding company debt Holding company cumulative preference shares Holding company non-cumulative preference shares Loss Given Failure notching Additional Preliminary Rating Notching Assessment Government Support notching Local Currency Rating ba1 Baa3 (P)Ba1 Foreign Currency Rating Baa3 Ba1 ba2 (hyb) (P)Ba2 (hyb) Ba2 (hyb) -2 ba3 -- (P)Ba3-2 ba3 (hyb) Ba3 (hyb) Ba3 (hyb) Source: Moody's Financial Metrics Ratings Exhibit 7 Category THE ROYAL BANK OF SCOTLAND GROUP PLC Outlook Baseline Credit Assessment Adjusted Baseline Credit Assessment Senior Unsecured Subordinate Jr Subordinate Pref. Stock Non-cumulative Pref. Shelf Non-cumulative Commercial Paper Other Short Term Moody's Rating Stable Baa3 Ba2 Ba2 (hyb) Ba3 (hyb) (P)Ba3 P-3 (P)P-3 THE ROYAL BANK OF SCOTLAND PLC Outlook Bank Deposits Baseline Credit Assessment Adjusted Baseline Credit Assessment Counterparty Risk Assessment Senior Unsecured Subordinate Jr Subordinate -Dom Curr Commercial Paper Other Short Term Stable Baa2/P-2 ba2 ba1 A3(cr)/P-2(cr) Baa2 Ba3 Ba3 (hyb) P-2 (P)P-2 Source: Moody's Investors Service 8 11 April 218

9 Endnotes 1 Scorecard ratios are derived as follows: latest reported period (TCE/RWA), latest annual period (Market Funds/Tangible Banking Assets, Liquid Banking Assets/Tangible Banking Assets), worse of [average of the last three years and latest interim period, latest period annual or interim]: (Problem Loans/Gross Loans, Net Income/Tangible Assets). Scorecard ratio data is shown through end Income excluding own credit adjustments, loss on redemption of own debt, and strategic disposals 3 excluding restructuring, litigation and conduct costs, and VAT recoveries 9 11 April 218

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11 CLIENT SERVICES 11 Americas Asia Pacific Japan EMEA April 218