London 2017 (Reuters Breakingviews) - The Bible admonishes the unfairly smitten to turn the other cheek in order to reach paradise. Royal Bank of Scotland shareholders, who have borne repeated slaps in the face in the form of heavy and recurring losses since the financial crisis, are no strangers to pain in pursuit of salvation. On Friday there was evidence that deliverance, in the form of dividends, may be nearer at hand.
Investing in the state-controlled lender has been a triumph of hope over bitter experience. RBS shares have underperformed the Euro STOXX banks index by 27 percent over the past five years. But second-quarter earnings of 838 million pounds ($1.1 billion) – which helped the bank register its first half-year net profit since 2014 – gave a better glimpse of the double-digit return on equity RBS’s core business generates once it is no longer burdened by exceptional costs.
First-half penalties fell to 396 million pounds – less than a third of the amount that RBS shelled out in the same period last year. Last month’s 3.6 billion pound payment to American regulators leaves it with just one big U.S. settlement. Granted, that fine is expected to exceed RBS’s 3 billion pounds in provisions, making it likely the bank will once again report a full-year loss. But from 2018 a greater proportion of earnings should accrue to shareholders rather than being snaffled by regulators.
There are further obstacles to RBS paying a dividend for the first time since 2008. The bank needs European authorities to sign off on a revised plan to restructure mid-sized lender Williams & Glyn. It also needs to pass the Bank of England’s stress tests.
And then there is the subdued UK economy on which RBS increasingly depends. That said, the lender’s 14.8 percent core Tier 1 capital ratio is 180 basis points above its target, giving it a generous buffer to cushion any rise in bad debts. A plan to reduce costs by a further 1.5 billion pounds by 2020 provides extra comfort.
At nearly 0.9 times tangible book value, RBS shares trade at a discount to healthier rival Lloyds. As the prospect of dividends draws nearer, investors will no longer require mere faith to believe that valuation gap will close.
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