RBS Rallies on Encouraging Q1 Earnings - Analyst Blog

The Royal Bank of Scotland Group plc's RBS share price jumped 7.89% to $11.21, following the impressive earnings in first-quarter 2014. First-quarter 2014 profit from continuing operations came in at £1.28 billion ($2.12 billion), rising more than twofold from £476 million ($739.4 million) in the prior-year quarter.

Results were positively driven by lower loan impairment losses and reduced operating expenses. Additionally, the results reflected higher net interest income. However, reduced non-interest income was on the downside.

Operating income almost doubled to £1.5 billion ($2.5 billion) on a year-over-year comparison. The rise was attributed to the lower impairment losses.

Furthermore, division-wise, in the first quarter, Central items division reported operating loss of £75 million ($124 million), while other segments reported operating profits. RBS Capital Resolution (RCR), created in Jan 2014, reported operating loss of £6 million ($9.9 million).

Performance in Detail

Net interest income inched up 1.0% on a year-over-year basis to £2,698 million ($4,465 million) in the first quarter. Group net interest margin increased 18 basis points to 2.12%, driven by repricing activities across a number of divisions.

Non-interest income came in at £2,355 million ($3,897 million), down 5.4% year over year. The decline reflected de-risking activities in the Markets division. Moreover, US Retail & Commercial divisions recorded reduced fee income due to slower mortgage refinancing activity and lower deposit fees in the quarter, partially offset by elevated income in UK Retail and UK Corporate units.

Operating expenses for the quarter totaled £3,190 million ($5,279 million), down 5.6% over the prior-year quarter, mainly due to lower administrative expenses. Further, planned cost reduction initiatives in the retail & commercial banking businesses along with re-sizing of the Markets division were the positives. Moreover, cost to income ratio improved to 63% from 66%.

Loan impairment losses decreased 65.3% to £360 million ($596 million) from the prior-year quarter. This was primarily led by improvement in all portfolios.

Balance Sheet

As of Mar 31, 2014, RBS exhibited a strong capital position. Funded assets stood at £746 billion ($1,241 billion), down 14.8% year over year. Total assets were £1,024 billion ($1,704 billion), down 21.7% year over year.

Loans and advances to customers were £443 billion ($737 billion), down 10% year over year. Loan to deposit ratio was 97% compared with 99% in the prior-year quarter.

As of Mar 31, 2014, Common Equity Tier 1CET ratio was 9.4% (transitional PRA basis), compared with 8.6% as of Dec 31, 2013. RBS continues to target a fully loaded Basel III CET1 ratio of 11% by the end of 2015 and 12% or above by the end of 2016.

Risk-weighted assets came in at £414.3 billion ($689 billion), down 3.4% sequentially.

Outlook for 2014

With the ongoing economic recovery in the UK, management anticipates modest increase in the net interest margin in the upcoming quarters. With credit trends being favorable in the first quarter, impairment losses on UK and Irish portfolios, excluding RCR, are anticipated to improve in 2014.

Margins are expected to be slightly up and strategic initiatives to result in cost reductions and improve efficiency in 2014. Though full implementation of these actions will take two to three years, management anticipates the underlying cost base to be lower by £1 billion in 2014.

Sale of Interest in Direct Line Group (DLG)

During the quarter, RBS completed the sale of residual interest of 423.2 million ordinary shares in DLG.  The shares were sold at a price of £2.63 pence per share yielding gross proceeds of £1,113 million and realizing a gain of £191 million. Notably, this sale excludes 4.2 million shares vested by RBS to Direct Line Group management as long-term incentive plan awards.

Performance of Other Foreign Banks

Impacted by a disappointing top-line performance, Deutsche Bank AG DB reported net income of €1.1 billion ($1.5 billion) in the first quarter of 2014, down from €1.7 billion ($2.2 million) in the prior-year quarter. However, decreased expenses, lower provision for credit losses and a strong capital position were the positives.

Brazil's Itau Unibanco Holding S.A. ITUB reported first-quarter 2014 recurring earnings of R$4.5 billion ($1.90 billion), up 29% year over year. Including non-recurring items, net income came in at R$4.4 billion ($1.86 billion), up 25.7% year over year. The year-over-year increase was primarily attributed to reduced expenses for provision of loan and lease losses and increased managerial financial margin along with higher banking service fees and income from banking charges.

Another foreign bank – UBS AG UBS will report first-quarter 2014 results on May 6.

Our Viewpoint

We expect RBS' diversified business model and sound financial position to contribute to its overall growth going forward. Though ongoing restructuring will help counter some of the challenges, increased competition, volatility in the global economy and the new regulations will remain plausible concerns.

Shares of RBS currently carry a Zacks Rank #4 (Sell).