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Banks
www.fitchratings.com 7 April 2017
United Kingdom
The Royal Bank of Scotland Group Plc Full Rating Report
Key Rating Drivers
Improved Risk Profile: The Royal Bank of Scotland Group plc’s (RBSG) ratings primarily
reflect the group’s significantly improved risk profile and acceptable capitalisation that provides
a sizable buffer for expected conduct charges, but also the group’s weak performance and the
remaining challenges it faces.
Significant Challenges Remain: Challenges that need to be addressed include uncertainty
over the timing and size of potential fines for legacy US residential mortgage-backed securities
(RMBS) activities, meeting the remaining state-aid obligation following the failure to divest
branches grouped under Williams & Glyn (W&G) by the end-2017 deadline, weak profitability
and the restructuring of the group.
Acceptable Capitalisation: The group’s common equity Tier 1 (CET1) ratio dropped by 210bp
to 13.4% at end-2016, but it remained above the medium-term target of 13%, providing a
cushion for the expected conduct charges. The fall was mainly due to a US RMBS-related
provision, restructuring costs, a dividend payment to the government and the accelerated
payment to the group’s pension fund, partially offset by the continuing deleveraging of its
Capital Resolution division. The Fitch Core Capital (FCC) ratio reduced to 14.7% at end-2016.
Profitability Is a Key Weakness: Profitability is under significant pressure from high conduct
and restructuring costs. We expect the group to continue to report losses in 2017 and possibly
in 2018. Longer-term profitability should be stronger and less volatile if the group’s turnaround
strategy is successful. For now, the continuing restructuring of the group weighs on our overall
assessment of the group’s company profile, management and strategy relative to UK peers.
Reduced Impaired Loans: RBSG’s gross impaired loan ratio of 3.1% at end-2016 is still
higher than its UK peers, but the results of the 2016 Bank of England stress-test indicated that
the asset quality of RBSG’s core domestic portfolio would be resilient to a severe stress. A
large portion of problem assets are in its Irish subsidiary, Ulster Bank Ireland DAC.
Improved Funding and Strong Liquidity: The group’s funding is more balanced than it was in
the past, with an improved balance between the maturities of assets and liabilities, a much
reduced reliance on wholesale funding and a large, high-quality liquidity buffer. We expect
active wholesale issuance to meet minimum requirement for own funds and eligible liabilities
(MREL), set at 23.5% of the group’s risk-weighted assets (RWAs), by 2022.
Holdco and Opco Ratings Equalised: RBSG’s ratings are primarily based on its role as a
holding company and reflect the absence of holding company double leverage.
Rating Sensitivities
Disruptive Fine or Litigation: RBSG’s ratings could be downgraded if the imposed fines are
materially higher than expected, or if litigation or reputation risk proves particularly disruptive, or
if consequences of the delayed divestment of W&G prove detrimental to the group’s franchise
and business model. A negative rating action could also be triggered by a severe and structural
deterioration of the operating environment following the UK’s decision to leave the EU.
Medium-Term Rating Upside: An upgrade of the group’s Issuer Default Ratings (IDRs) and
Viability Rating (VR) would require the removal of the uncertainties around the expected fine,
remaining state-aid obligation and still material execution risk from restructuring the group,
assuming that the group maintains good capitalisation and reaches a sound profitability.
Ratings
The Royal Bank of Scotland Group plc; The Royal Bank of Scotland PLC; National Westminster Bank Plc Foreign Currency
Long-Term IDR BBB+ Short-Term IDR F2
Viability Rating bbb+ Support Rating 5 Support Rating Floor NF
The Royal Bank of Scotland International Limited Foreign Currency Long-Term IDR BBB+ Short-Term IDR F2 Support Rating 2
The Royal Bank of Scotland N.V. Foreign Currency Long-Term IDR BBB+ Short-Term IDR F2 Support Rating 2
Sovereign Risk
Foreign-Currency Long-Term IDR AA Local-Currency Long-Term IDR AA
Outlooks
Foreign-Currency Long-Term IDR Stable Sovereign Foreign-Currency Long-Term IDR
Negative
Sovereign Local-Currency Long-Term IDR
Negative
Financial Data
The Royal Bank of Scotland Group plc
31 Dec 16
31 Dec 15
Total assets (USDbn) 982.5 1,208.4 Total assets (GBPbn) 798.7 815.4 Total equity (GBPbn) 42.3 48.2 Operating profit (GBPm) -451 1,031 Published net income (GBPm)
-5,248 -1,185
Comprehensive income (GBPm)
-4,181 -2,681
Operating ROAA (%) -0.05 0.11 Operating ROAE (%) -1.00 1.94 Internal capital generation (%)
-16.44 -3.26
Common equity Tier 1 ratio (%)
13.40 15.50
Tier 1 ratio (%) 17.70 19.10 Fitch Core Capital/risk-weighted assets (%)
14.70 16.21
Related Research
The Royal Bank of Scotland Group plc - Ratings Navigator (February 2017)
Fitch Affirms Royal Bank of Scotland Group at ‘BBB+’; Outlook Stable (February 2017)
2017 Outlook: UK Banks (December 2016)
Analysts
Joanna Drobnik, CFA +44 20 3530 1318 joanna.drobnik@fitchratings.com
Christian Scarafia +44 20 3530 1012 christian.scarafia@fitchratings.com
Banks
The Royal Bank of Scotland Group Plc
April 2017 2
Operating Environment
Brexit-Driven Uncertainty a Key Challenge
RBSG’s business is anchored in the UK (AA/Negative; Macro Prudential Indicator of MPI 1 –
low risk), where it operates through two main banks: RBS and National Westminster Bank Plc
(NatWest, an RBS subsidiary). The group is also exposed to the Irish operating environment
(A/Stable; Macro Prudential Indicator of MPI 1 – low risk) through Ulster Bank Ireland DAC.
Our assessment of its operating environment considers the UK’s sovereign rating as well the
economic environment in which the group operates and the framework that regulates and
supervises its activities. While the UK has benefited from a strong recovery since the last crisis,
we expect that GDP growth will reduce materially as the country prepares to leave the EU.
Fitch Ratings believes that uncertainty in the period until Brexit is likely to result in reduced
investment and consumption, with possible rises in unemployment, accelerating inflation and
falling asset values. We do not believe that these act as a constraint to RBSG’s VR. As the UK
private sector is highly indebted, deteriorating affordability could affect RBSG’s asset quality,
although the affordability should benefit from lower base rates for a longer period of time.
The group is regulated by the Prudential Regulation Authority and by the Financial Conduct
Authority, and its deposits are protected by the UK’s deposit insurance scheme. Fitch views
financial sector regulation in the UK as highly developed and transparent, with a focus on
strengthening capital, and, within the retail sector, on controlling household indebtedness and
mortgage affordability. Macro-prudential policy tools are being tested to ensure control over the
risk of the increase in base rates and the large portion of UK households’ wealth invested in
property. The UK regulatory environment has an effective bail-in regime enacted in domestic
legislation, which we expect will continue to be applied after the exit of the UK from the EU.
Company Profile
Transformation into UK-Focused Commercial Bank Is Progressing Well
In the UK, RBSG has leading market shares in commercial and SME banking as well as in
some segments of retail banking through its RBS and NatWest brands. It is also a leading
private bank in the UK through Coutts & Company (Coutts). Through Ulster entities, it has the
largest franchise in Northern Ireland and is the third-largest bank in Ireland. The group is active
in offshore banking through The Royal Bank of Scotland International Limited (RBSIL).
RBSG’s reshaped business model was implemented in 2014, aiming at improving returns and
splitting the group into three core business lines. Personal and Business Banking (PBB) serves
UK retail and SME businesses with turnover below GBP2 million and retail and commercial
customers in Ireland. Commercial and Private Banking (CPB) includes UK commercial and
mid-corporate clients, high-net-worth individuals and offshore banking through RBSIL.
Corporate and Investment Banking (CIB) was rebranded NatWest Markets (NWM) in
December 2016 and is undergoing a multiyear transformation, which was launched in 2015.
The business has a core focus on UK and western Europe corporates and global financial
institutions.
By end-2015, RBSG had substantially completed the run-down of RBS Capital Resolution
(RCR, established in 2013 to separate and wind down capital intensive assets) a year ahead of
schedule, with residual assets transferred to Capital Resolution (CR). CR was established in
February 2015 to sell and run down portions of CIB that were outside of the new business’s
scope. As part of this process, the US broker-dealer business, RBS Securities Inc. is being
materially reduced in size. RBSG plans to wind up CR by end-2017 and transfer any remaining
assets back into the rest of the group, mainly into NWM and CPB.
Related Criteria
Global Bank Rating Criteria (November 2016)
Global Non-Bank Financial Institutions Rating Criteria (March 2017)
Banks
The Royal Bank of Scotland Group Plc
April 2017 3
Divestment of Williams & Glyn Proved too Challenging
RBSG is required to fully separate and divest all RBS branches in England and Wales and all
NatWest branches in Scotland, referred to as W&G, by end-2017 to meet the EU state-aid
conditions imposed after its bail-out by the UK government. However, the W&G divestment
process has proven to be extremely complex and the bank announced that it would not be able
to meet the end-2017 deadline imposed by the EC.
Until early 2016, RBSG had been working towards establishing W&G as a separate licensed
bank and divesting it through an initial public offering or outright sale. This plan was abandoned
in 2016 and replaced by a plan to sell the business to another bank, which was also
unsuccessful. In February 2017, the commissioner responsible for EU competition policy has
proposed an alternative plan, which, if agreed, would bring a faster and more certain
conclusion to RBSG’s remaining state-aid obligations than the existing requirement to sell
W&G.
Under the proposed plan, RBSG would deliver a package to promote competition for banking
services to UK SMEs. This would include funding to help eligible challenger banks serve UK
SMEs, a fund that eligible challenger banks can access to increase their business banking
capabilities, funding to invest in fintech for business banking and access to RBSG branches for
the business customers of challenger banks.
RBSG took a GBP750 million provision in 2016 to provide for the proposed package and
expects to take additional restructuring charges in 2017 and 2018 to reincorporate the W&G
business into the RBS franchise. This is in addition to more than GBP1.7 billion that RBSG has
spent on W&G’s divestment programme over the past three years. Nevertheless, we believe
the ultimate cost of the new plan to RBSG, including the impact on its franchise, is likely to be
lower than under the previous plan.
International Presence Has Been Significantly Reduced
RBSG has gradually reduced its overseas presence since 2014. In October 2015, it completed
the sale of Citizens, a mid-sized US bank, a year ahead of schedule. In April 2016, it sold the
international segment of Coutts to focus on the UK part of the private banking business. The
group has also wound down non-UK transaction banking services and exited from 25 of the 38
countries where it had an international presence.
Divisional Breakdown Total income Impairment loss/release Operating loss/profit RWAs (GBPbn)
a
(GBPm) 2016 2015 2016 2015 2016 2015 2016 2015
UK Personal and Business Bankingb 5,290 5,200 -83 7 2,202 2,169 32.7 33.3
Ulster Bank RoIc
573 550 113 141 229 264 18.1 19.4 Personal and Business Banking 5,863 5,750 30 148 2,431 2,433 50.8 52.7 Commercial Banking 3,415 3,254 -206 -69 1,273 1,384 78.5 72.3 Private Banking 657 644 3 -13 149 113 8.6 8.7 RBS International 374 367 -10 0 195 211 9.5 8.3 Commercial and Private Banking 4,446 4,265 -213 -82 1,617 1,708 96.6 89.3 NatWest Markets 1,521 1,407 0 5 201 -55 35.2 33.1 Central items 120 377 0 -54 455 272 1.5 8.6 RBS core 11,950 11,799 -183 17 4,704 4,358 184.1 183.7 Capital Resolution -415 402 -253 725 -1,432 -412 34.5 49.0 Williams & Glyn 837 833 -42 -15 402 459 9.6 9.9 Total managed
d 12,372 13,034 -478 727 3,674 4,405 228.2 242.6
Total reported 12,590 12,923 -478 727 -4,082 -2,703 a Fully loaded Basel III
b Includes operations of Ulster Bank in Northern Ireland
c Ulster Bank DAC is a statutory entity, while Ulster Bank RoI is a divisional view.
d See table below for reconciliation between managed and reported operating profit
Source: RBSG, Fitch
Reconciliation Between Managed and Reported Operating Profit (GBPbn) 2016 2015
Managed 3,674 4,405 Own credit adjustment 180 309 Loss on redemption of own debt
-126 -263
Strategic disposals 164 -157 Restructuring costs -2,106 -2,931 Litigation and conduct costs
-5,868 -3,568
Write-down of goodwill - -498 Reported op profit/loss
-4,082 -2,703
Source: RBSG, Fitch
Williams & Glyn Divestment Costs Year (GBPm)
2014 378 2015 630 2016 706 Total 1,714
Source: RBSG, Fitch
Banks
The Royal Bank of Scotland Group Plc
April 2017 4
Ring-Fencing Will Add Complexity to Organisational Structure
The group structure has become simpler following the sale and wind down of international
operations. The requirement to establish a ring-fenced bank (RFB) in the UK will add some
complexity to the group’s organisational structure, but to a far lesser extent than at the more
internationally active UK banking groups, Barclays and HSBC. RBSG is targeting a “broad ring
fence”, under which the majority of activities (80% of RWAs), comprising UK and Irish-focused
banking services, will be housed inside the RFB. The non-ring-fenced group entities (NRFB)
will hold the remaining trading activities and the operations of RBSIL.
The implementation of the ring-fencing regime will significantly affect the management of the
group’s treasury operations, including internal and external funding arrangements. Each legal
entity will have to meet its own regulatory capital requirements, including Pillar 2A requirements,
and the RFB will have to meet the UK’s Systemic Risk Buffer. In addition, the establishment of
RFB and NRFB entities requires a significant legal and organisational restructuring.
Management and Strategy
We believe management has a high degree of depth and experience despite the large-scale
turnaround seen in the aftermath of the financial crisis. The new management team has been
in place since 2014 and includes individuals from inside and outside the group with significant
experience in the UK banking sector. Management has been responsible for developing the
group’s new strategy and further restructuring.
RBSG now has a consistent and clearly articulated strategy to become a simpler and stronger
bank, built around UK and Irish retail and commercial businesses. The group has completed
the second phase of its plan, centered on the transformation of its core businesses and the exit
from non-core businesses. The management team has been successful in achieving majority
its targets. However, there are still significant items outstanding, mainly satisfying final state-aid
obligations, NWM transformation and US RMBS investigation, which are likely to take
considerable time to resolve. We believe that meeting some of these targets will be challenging
and may be delayed.
In the medium term, RBSG targets net growth in PBB and CPB customer loans equal to at
least UK GDP growth, with a 3% target for 2017. On the other hand, NWM will see its business
much reduced and focused on supporting the group’s corporate clients. CR will continue to be
deleveraged with planned reduction in RWAs to between GBP15 billion and GBP20 billion
(excluding Alawwal Bank stake) and wind-up at end-2017.
Strategic Targets
KPI Long-Term Targets
CET1 ratio 13%
Cost/income ratio <50%
ROTE ≥12%
Source: RBSG, Fitch
End-2016 Simplified Legal Entity Structure
(Pre-Interim Transfers)
a Currently Adam & Co. plc
b New intermediate holding company established Jan 2017
c Currently RBS plc
Source: Fitch, Transaction documents
RBSG
RBS plc
NatWest Adam & Co.
Coutts & Company
RBS Securities Inc.
RBSILUlster Bank
Ltd.
Ulster DAC
100%
100%
100%100%100%
100%
44%
56%
RBSG
NatWest Holdings Limitedb
NatWest Markets plcc RBSIL
RBS plca
NatWest Ulster DAC
RBS Securities Inc.
Coutts &
CompanyUlster Bank Ltd.
100%
100% 100%
100%
100%100%100%
100% 100%
Ring-fenced
Bank
New Entity Re-Named Existing Entity
2019 Proposed Simplified Ring-Fenced Legal Entity Structure
Banks
The Royal Bank of Scotland Group Plc
April 2017 5
The group plans to generate about 90% of income from its UK operations and to reduce
operating costs by a further GBP2 billion over the next four years, in addition to the
GBP3.1 billion reduction achieved since January 2014. Long-term targets have been set and
the group plans to achieve these mainly through continuing investment in IT platforms and
application simplification, NWM restructuring and the run-down of CR.
Risk Appetite
Improving Internal Controls
RBSG has simplified its risk function, enhanced accountability and responsibilities, and made
significant progress in improving its overall risk profile. The risk-appetite framework is now
better aligned to FSB’s guidance on risk culture and is expected to be fully implemented and
embedded across the group by end-2017. Risk-appetite statements are in place for all strategic
and material risks (such as credit, market, operational, conduct, pension, reputational,
concentration, financial crime and IT resilience risks), all business franchises, all functions and
some major operating legal entities. There are a range of risk limits for individual asset classes,
products, industries and countries. Control has been embodied into enterprise risk
management, which looks at key company risks in aggregate, and aims to ensure that risks are
controlled consistently across the group.
The group has refocused its business on its core franchises in the UK and Ireland and this
simplified business model makes effective risk management more easily achievable. The
progress that has been made in de-risking the business is evident in the impaired loans/gross
loans ratio, which has fallen to 3.1% at end-2016 from 9.5% at end-2013. While this is largely
due to deleveraging of non-core assets and has been assisted by benign UK economic
conditions, it also reflects more conservative underwriting standards.
Legacy Conduct Risk
Despite significant progress made during 2015 and 2016, RBSG continues to face heightened
operational risk through numerous reviews and investigations by authorities in numerous
jurisdictions and business areas, which are difficult to quantify precisely. Regulatory
investigations and litigation include the mis-selling of US RMBS, mis-selling payment protection
insurance (PPI) in the UK, LIBOR and foreign-exchange (FX) setting practices in the US and
the UK, mis-selling of swap to SMEs in the UK and a lawsuit over UK 2008 capital raising.
Overall litigation costs and fines, and customer redress taken by RBSG between 2011 and
2016 amounted to GBP18.5 billion. We expect further material misconduct costs, primarily from
further fines and similar charges related to the US RMBS investigation. Unused balance-sheet
provisions at end-2016 totalled GBP11 billion, split GBP6.8 billion related to US RMBS,
GBP1.3 billion related to PPI, GBP1.1 billion related to other customer redress and GBP1.9
billion related to litigation and other regulatory proceedings.
As a result of the legacy conduct issues, RBSG has strengthened its conduct and compliance
functions and implemented remediation programmes to reduce and mitigate the group’s material
operational risks. Nevertheless, operational risks will remain elevated during the group
restructuring particularly with respect to the implementation of the UK ring-fencing regime and the
restructuring of NWM business. These carry significant execution and delivery risk and are being
delivered against the backdrop of cost challenges, putting significant pressure on the group’s
ability to maintain effective internal controls. However, the bank has shown that it has been able
to control these risks well and it has made significant investments to strengthen its IT platforms.
Modest Market Risk with Adequate Controls
The group’s exposure to market risk has reduced significantly, reflecting disposals of volatile
assets and the exit from a wide range of trading activities, including the downscaling of
activities at the group’s US broker dealer. The majority of RBSG’s traded market risk exposure
arises in NWM and CR. The majority of its non-traded market risk exposure (interest-rate risk in
the banking book, structural FX positions and equity positions) arises mainly from retail and
0
1,000
2,000
3,000
4,000
5,000
6,000
7,000
20
11
20
12
20
13
20
14
20
15
20
16
Source: RBSG, Fitch
Litigation and Conduct Costs(GBPm)
Banks
The Royal Bank of Scotland Group Plc
April 2017 6
commercial banking activities. The group’s earnings are adversely sensitive to a reduction in
short-term interest rates, with a 100bp fall in interest rates reducing next year’s net interest
income by about GBP378 million (equivalent to 0.8% of total equity) at end-2016.
Market risk is managed centrally and appetite is expressed in the form of policy statements,
dealing authorities and limits based on value-at-risk (VaR) and stressed VaR, positions,
sensitivity analyses and stress testing.
In March 2016, RBSG made a single payment of GBP4.2 billion to the RBSG Group Pension
Fund, instead of a series of annual contributions up to 2023, removing an element of pension
risk. The next valuation date will take place at end-2018. This provides increased certainty on
contribution commitments and the pension balance-sheet position and improves capital
planning.
Financial Profile
Asset Quality
As a result of the continuing deleveraging, the group’s gross loans and advances reduced by
65% between 2008 and 2015. Last year saw, for the first time since 2008, an increase in gross
loans and advances, of 4%, to GBP327 billion, as healthy growth in core retail and commercial
businesses more than offset the disposals of non-core assets. The geographical profile of
lending has also changed significantly, especially following the disposal of Citizens, with UK
lending now accounting for 93% of gross loans, with the remainder almost entirely in Ireland.
UK lending is mostly in the form of residential mortgages and non-commercial real estate
(CRE) corporate and SME lending. UK mortgage loans increased by 11% in 2016 and
accounted for 42% of gross loans at end-2016. Non-CRE corporate and SME lending in the UK
increased by 5% in 2016, with the biggest growth in the finance leases, retail and wholesale,
hotels and restaurants, and utilities sectors, and accounted for 35% of gross loans at end-
2016. Unsecured personal lending in the UK continues to decline and accounted for just 4% of
gross loans at end-2016, reflecting a reduced appetite for this type of lending.
UK mortgages have been extended predominantly to prime residential borrowers and at
relatively conservative loan/value (LTV) ratios (end-2016: average LTV of 56% in the UK PBB
book, which includes Northern Ireland; the proportion of the portfolio with LTVs of more than
90% or with no index was 3.5%, in line with the rest of the market). More than a fifth of the
owner-occupied mortgages were interest only. The portfolio also includes GBP16.7 billion of
buy-to-let mortgages.
Irish mortgages at Ulster Bank RoI (Ulster RoI) accounted for above 4% of gross loans at end-
2016. The quality of the Irish book remains much weaker, where, despite significant
improvement, the average LTV was 76% at end-2016 (end-2012: 112%, including Northern
Ireland), and 31% of mortgages had LTVs of above 90% (end-2012: 66%, including Northern
Ireland), reflecting the dramatic fall in Irish property prices in the aftermath of the crisis.
Industry exposure remains concentrated, albeit to the lesser extent than in the past, with the
largest concentration to the property sector, mostly CRE in the UK. Overall, CRE exposure was
GBP26.3 billion at end-2016 and accounted for 78% of FCC. New CRE lending is extended to
support key customers and is focused on the UK market. The proportion of the book with LTVs
above 70% (10% at end-2016) has dropped significantly over recent years, due to accelerated
divestments of legacy assets, improvements in the economy and new lending extended at
lower LTVs. Exposures with LTVs greater than 100% are predominantly legacy deals and
accounted for less than 5% of the portfolio.
Loan Book Breakdown at End-2016
(GBPbn) Gross loans
REIL (%)
REIL coverage
(%)
Government 6.1 0.0 100
Finance 33.1 0.2 84 Mortgages 153.3 2.7 25 Unsecured personal
14.5 7.7 81
Property 34.8 3.9 36 Construction 4.2 6.2 52 Manufacturing 9.6 1.8 52 Finance leases
12.3 1.1 57
Retail, wholesale and repairs
12.8 2.2 64
Transport and storage
6.4 21.6 30
Health, education and leisure
11.5 3.3 34
Hotels, restaurants
6.1 3.5 51
Utilities 3.9 2.4 53 Other 18.8 3.9 54 Total 327.5 3.1 43
REIL: Risk Elements in Lending Source: RBSG, Fitch
Banks
The Royal Bank of Scotland Group Plc
April 2017 7
Transport includes exposure to shipping finance, which, in line with the de-risking of the balance
sheet, has reduced to GBP4.6 billion at end-2016 (end-2015: GBP6.8 billion). It is mostly
managed within CR and related to exposure secured by ocean-going vessels. Conditions in the
portfolio remained depressed in 2015 and 2016, resulting in a weakened collateral cover with an
overall LTV of the CR part of the portfolio at 102% (end-2015: 85%). RBSG has also been
reducing its exposures to the natural resources sectors, with oil and gas exposures amounting to
a modest GBP2.9 billion at end-2016, of which only about 5% was within CR. See table opposite
for a breakdown of other notable sub-sector corporate exposures at end-2016.
Asset quality has improved further in 2016, primarily reflecting further disposals in CR and a
portfolio sale in Ulster RoI, partially offset by a deterioration in the shipping portfolio. The
results of the 2016 Bank of England stress-testing indicated that the asset quality of RBSG’s
core domestic portfolio would be resilient to a severe stress. However, the group’s asset quality
remains weaker than generally seen at UK banks, with a high proportion of risk element in
lending (REIL; or non-performing loans) at Ulster RoI and within CR. The table above breaks
down asset quality by geography and product.
Loans that are past due by 90 days or more and that require active management to minimise
losses, classified as REIL but not impaired, were GBP1.2 billion at end-2016 and are included
in Fitch’s impaired loans ratios in the spreadsheets at the back of this report.
Other Earning Assets: Significantly De-Risked
RBSG holds a sizeable portfolio of debt securities (GBP73 billion at end-2016), mainly split
between available for sale and held for trading, with a small amount of held to maturity and
loans and receivables. Over 80% of the securities were issued by central and local
governments (of which almost half was in the UK and the US). The credit risk of the securities
continues to improve, with 98% of debt securities rated investment grade at end-2016 (93%, ‘A’
or above). Within the significantly reduced ABS portfolio (GBP7 billion at end-2016), 76% were
rated ‘A’ and above.
RBSG has a sizeable reverse repurchase (repo) agreements book (GBP42 billion at end-2016)
which is largely match-funded (via repo agreements, GBP32 billion). RBSG is also a significant
participant in the derivative markets – mainly interest-rate swaps. Counterparty credit risk is
mitigated via netting and collateral arrangements, together covering 95% of GBP247 billion
gross exposures at end-2016.
Asset Quality and Impairment Allowances (Breakdown)
Gross loans REIL (NPLs) Provisions
(GBPm) 2016 (%)a +/− (%) 2015 (%)
a 2016 (%)
b 2015 (%)
b 2016 (%)
c 2015 (%)
c
UK Residential mortgages 137,427 42 11 123,653 39 943 0.7 1,083 0.9 143 15 158 15 Personal lending 14,198 4 -1 14,348 5 1,060 7.5 1,262 8.8 853 80 1,085 86 Property and construction 37,942 12 0 38,006 12 1,543 4.1 2,814 7.4 537 35 1,282 46 Other 115,833 35 5 110,193 35 3,133 2.7 2,198 2.0 1,299 41 1,182 54 Total UK
305,400 93 7 286,200 91 6,679 2.2 7,357 2.6 3,150 47 4,037 55
Europe Residential mortgages 15,548 5 12 13,908 4 3,144 20.2 2,550 18.3 872 28 844 33 Personal lending 265 0 -66 775 0 52 19.6 49 6.3 46 88 45 92 Property and construction 1,055 0 -47 1,993 1 85 8.1 1,008 50.6 84 99 966 96 Other 3,920 1 -45 7,148 2 279 7.1 1,011 14.1 165 59 864 85 Total Europe
20,788 6 -13 23,824 8 3,560 17.1 4,618 19.4 1,250 35 2,974 64
Rest of World 1,290 0 -75 5,087 2 71 5.5 181 3.6 55 77 127 70 Total gross loans 327,478 100 4 315,111 100 10,310 3.1 12,156 3.9 4,455 43 7,138 59 a Percentage of total gross loans;
b Percentage of gross loans;
c Coverage of impaired loans
Source: RBSG, Fitch
Banks
The Royal Bank of Scotland Group Plc
April 2017 8
0
0.3
0.6
0.9
1.2
1.5
0
10,000
20,000
30,000
40,000
50,000
20
08
20
09
20
10
20
11
20
12
20
13
20
14
20
15
20
16
(%)(GBPm)
Interest receivable (LHS)
Interest payable (LHS)
NIM (RHS)
Source: RBSG, restated by Fitch
Net Interest Revenue and Margin
Earnings and Profitability
RBSG has been loss-making since 2008, with a GBP5.2 billion net loss reported in 2016.
Subject to resolving or providing for all significant legacy issues in 2017, the group expects to
become profitable in 2018.
The loss reported in 2016 was largely due to GBP5.9 billion of additional conduct charges and
GBP2.1 billion of further restructuring costs. In addition, the group has paid the final dividend
access share (DAS) of GBP1.2 billion to the UK government, increasing the loss attributable to
ordinary shareholders. However, we consider the underlying profitability of the group’s core
businesses to be adequate. This should help RBSG to return to profit once the majority of
legacy conduct issues, especially with relation to US RMBS, have been resolved and the
restructuring has been implemented.
UK PBB, Commercial Banking (CB) and RBSIL are performing well on an underlying basis,
excluding restructuring and conduct costs, with strong returns on allocated equity, adequate
efficiency and positive outlook for both income and costs. Ulster RoI, Private Banking (PB) and
NWM, on the other hand, are being reposition for returns, with NWM’s transformation being the
biggest challenge. Ulster RoI stopped being loss making in 2014 but it is likely to continue to
suffer from low income in the medium term because of a high proportion of low-margin tracker
mortgages and a high cost base relative to the size of its core business.
Following the sale of its international business, PB is being repositioned to focus on UK
customers and became profitable in 2016.
The group’s total income continues to decline, in line with the shrinkage of the balance sheet. It
was down 3% yoy in 2016, mainly due to the reduced scale and resources in NWM and the
run-down of CR. We expect income to start to pick up from 2017 as the core businesses grow.
The net interest margin (NIM) has been improving since 2013, as a result of a better
management of funding costs and legacy funding rolling off, but remains low at 1.15% in 2016
(2015: 1.09%). Higher-yielding assets, such as credit card balances and personal unsecured
loans, have declined in volume while the proportion of lower-margin secured lending has
increased putting downward pressure on NIM.
The interest-rate cut in 2016 added additional pressure, but it has been partly offset by access
to cheap funding from the Bank of England’s GBP100 billion Term Funding Scheme. The
progressive replacing of maturing structural hedges, which added GBP1.3 billion to net interest
income, will also put pressure on NIM over the coming years.
Efficiency at the group remains low, with a Fitch-calculated cost/income ratio of 100% in 2016.
As a result of cost savings, underlying operating costs reduced by a further GBP1 billion in
2016 to GBP8.4 billion, with a further targeted reduction of GBP2 billion over the next four
years, of which GBP0.75 billion is planned for 2017.
Netted against the savings are restructuring costs which totalled GBP2.1 billion in 2016, of
which almost GBP1.5 billion related to the remaining state-aid obligations. From 2014 to 2016,
the group’s restructuring costs totalled GBP6.2 billion and RBSG is expecting additional
GBP2 billion over 2017 to 2019 (excluding W&G), of which GBP1 billion in 2017. Conduct costs
amounted to GBP5.9 billion in 2016 and included provisions in respect of US RMBS, PPI, the
UK 2008 capital raising and tracker mortgages in Ulster RoI.
RBSG recorded loan impairment charges (LICs) of GBP0.5 billion in 2016, mainly relating to the
legacy shipping portfolio within CR and a single name charge in the oil and gas portfolio within
CB. We expect that LICs will remain moderate in the short to medium term, as the overall credit
profile of the group has improved. However, in the long term LICs are likely to rise, as a result of
deteriorating economic environment, which is forecast after the decision to leave the EU.
0
500
1,000
1,500
2,000
2,500
3,000
3,500
2014 2015 2016 2017e
Cost savings Restructuring costs
Source: RBSG, Fitch
Cost Savings vs. Restructuring Costs
(GBPm)
Banks
The Royal Bank of Scotland Group Plc
April 2017 9
Capitalisation and Leverage
The group’s CET1 ratio fell 210bp in 2016 to 13.4%, mainly due to a US RMBS-related
provision, further restructuring costs, the final DAS dividend and the accelerated contribution
into the group’s pension scheme, partially offset by the continuing deleveraging of CR. We
believe that despite this reduction capital provides a sizeable cushion for the expected conduct
and litigation charges. The group targets a normalisation of the CET1 ratio at about 13%, but
we believe that achieving it will depend on the size and timing of the litigations claims related to
US RMBS mis-selling.
The results of the 2016 Bank of England stress revealed that RBSG did not meet its CET1
capital or Tier 1 leverage hurdle rates before additional Tier 1 (AT1) conversion. After AT1
conversion, it did not meet its CET1 systemic reference point or Tier 1 leverage ratio hurdle
rate. To improve its capital position stress resilience RBSG has updated its capital plan, which
incorporates further savings and reductions in RWAs across the group. This is in addition to
actions already taken since end-2015, including an issuance of USD2.65 billion of AT1 in
August 2016.
RBSG estimates that its MREL will be equivalent to 23.5% of its RWAs by end-2022. The
group plans to build up its MREL compliant debt through issuance of senior unsecured bail-
inable holding company debt with targeted annual issuance of GBP3 billion to GBP5 billion
(GBP4.2 billion was issued in 2016).
RBSG’s regulatory leverage ratio is adequate and has improved significantly since end-2013,
helped by the issuance of GBP4 billion AT1 capital notes in 2015 and 2016, and a reduction in
leverage exposure in line with the deleveraging. The group reported a 5.1% leverage ratio at
end-2016, 50bp lower than at end-2015. The drop was driven by lending growth and the
reduction in Tier 1 capital.
Funding and Liquidity
RBSG has reshaped its balance sheet and improved the quality of its funding and liquidity (see
chart opposite). The group is largely funded by customer deposits, which account for about
70% of total funding excluding derivatives. The Fitch-calculated loans/deposits ratio was 93%
at end-2016. However, we expect the ratio to increase to the group’s medium-term target of
about 100%, as a result of lending growth from PBB and CPB, and a shift to greater MREL
issuance leading to lower requirement for customer deposits.
The use of wholesale funding continues to decline, running off broadly in line with the disposal
of non-core assets and RBSG continues to expect maturities to be greater than issuance
requirements. The group has also significantly extended the maturity profile of its wholesale
funding, with short-term wholesale funding reduced to GBP13.9 billion (excluding
GBP20.7 billion derivative collateral) at end-2016, representing 2.5% of funded assets
Asset encumbrance is modest and was at about 11% of the total balance sheet at end-2016.
The group has also increase the amount of unencumbered assets pre-positioned with various
central banks as collateral for liquidity facilities. These consist mostly of the liquidity portfolio
(see table opposite), other debt securities and loans.
The group’s liquidity position has been strong since the crisis, with a liquidity coverage ratio
(LCR) of 123% and an estimated net stable funding ratio (NSFR) of 121% at end-2016. The
excess liquidity also works as a cushion for imminent US RMBS litigation settlement. We
expect liquidity indicators to decline further once the US fine has been paid and other
uncertainty removed.
Capital Ratiosa
(GBPbn) 2016 2015 2014
Credit 162.2 166.4 264.7
Counterparty 22.9 23.4 30.4
Market 17.4 21.2 24
Operational 25.7 31.6 36.8
Total RWAs 228.2 242.6 355.9
CET1 capital 30.6 37.6 39.9
CET1 ratio (%) 13.4 15.5 11.2
Tier 1 capital 34.7 39.6 39.9
Tier 1 ratio (%) 15.2 16.3 11.2
Total regulatory capital
43.8 47.6 48.6
Total capital ratio (%)
19.2 19.6 13.7
Leverage ratio (%)
5.1 5.6 4.2
a Fully Loaded CRR
Source: RBSG, Fitch
Liquid Assetsª
(GBPbn) 2016 2015 2014
Cash and central bank balances
69.1 69.4 68.4
FSA eligible government bonds
26.1 25.8 25.7
Primary liquidity 95.2 95.2 94.1
Secondary liquidity
b 68.7 60.6 56.5
Total buffer 163.9 155.7 150.7
Carrying value 190.3 188.7 187.0
ª By liquidity value b High quality assets eligible for discounting at
central banks; breakdown not available Source: RBSG, Fitch
Liquidity Metrics
(%) 2016 2015 2014
Stress outflow coverage
a 139 227 186
LCR 123 136 112
NSFR 121 121 112
ª Liquidity portfolio as a percentage of stressed outflows under the worst of three severe stress scenarios Source: RBSG, Fitch
0
200
400
600
800
2012 2013 2014 2015 2016
Secured debt Sub debt
MTNs CPs/CDs
Interbank Repos
Customer deposits
Source: RGSB, Fitch
Funding Breakdown(excl. derivatives)
(GBPbn)
Banks
The Royal Bank of Scotland Group Plc
April 2017 10
Support
Support Possible but Unlikely
We believe that sovereign support for RBS and NatWest is possible but cannot be relied upon
to protect senior creditors. While we view the ability of the UK authorities to be strong, their
propensity to provide such support has reduced, as indicated by the legislation enacted to allow
resolution to take place through bail-in. Our opinion is reinforced by statements by the
regulatory authorities to the same effect.
In terms of legal provision, the EU’s Bank Recovery and Resolution Directive has been
transcribed into UK law and took effect on 1 January 2015. The bail-in powers, contained in the
Financial Services (Banking Reform) Act 2013 (the 2013 Act) have also come into force and
reinforce the provisions of the Banking Act 2009, under which a special resolution regime had
already been set up.
Debt Ratings
The ratings of all subordinated debt and hybrid securities issued by RBSG group companies
are notched down from the common VR assigned to individual group companies, reflecting
Fitch’s assessment of their incremental non-performance risk relative to their VRs (up to three
notches) and assumptions around loss severity (one or two notches).
These features vary considerably by instrument. Subordinated debt with no coupon flexibility is
notched down once from the VR for incremental loss severity. Upper Tier 2 subordinated debt
is notched down three times (once for loss severity and twice for incremental non-performance
risk). Innovative and non-innovative legacy Tier 1 and preferred stock is notched down either
four or five times, dependent on incremental non-performance risk (twice for loss severity and
either two or three times for incremental non-performance risk). Contingent convertible capital
notes are notched five times (twice for loss severity and three times for incremental non-
performance risk) given their fully discretionary coupon payment.
Banks
The Royal Bank of Scotland Group Plc
April 2017 11
Peer Analysis 2016 RBSG LBG Nationwide
a SGH Barclays
2016 2015 2016 2014 2016 2015 2016 2015 2016 2015
Asset quality Impaired loans/gross loans 3.15 3.88 1.84 2.09 0.60 0.68 0.70 0.75 1.63 1.93 Reserves for impaired loans/impaired loans
43.21 58.72 43.71 46.44 36.24 36.49 70.64 77.13 71.18 62.95
LICs/average gross loans 0.16 -0.26 0.13 0.09 0.04 0.05 0.03 0.03 0.57 0.49 Growth of gross loans 4.47 -10.87 0.44 -5.35 3.05 4.64 0.76 4.85 -1.67 -6.71 Profitability Operating profit/RWAs -0.20 0.42 2.28 2.82 3.70 3.99 2.18 2.09 0.78 0.75 NIM 1.15 1.09 1.27 1.56 1.44 1.60 1.47 1.54 0.96 1.05 Cost/income 100.26 98.69 66.58 61.59 58.12 57.09 57.74 59.45 76.04 81.00 LICs/pre-impairment operating profit
1,770.37 -239.14 13.29 5.83 5.46 5.04 3.39 3.54 45.48 44.02
Operating ROE -1.00 1.94 11.09 14.16 12.68 14.77 13.39 12.89 4.76 4.53 Operating ROA -0.05 0.11 0.59 0.76 0.59 0.68 0.65 0.64 0.23 0.21 Capitalisation and leverage FCC/FCC-adjusted RWAs 14.70 16.21 13.16 12.07 26.16 25.37 13.66 13.54 14.67 13.26 CET1 ratio
b 13.40 15.50 13.60 12.80 23.30 23.20 11.60 11.60 12.40 11.40
Total capital ratioc
22.90 24.70 21.40 21.50 33.80 30.90 17.30 17.40 19.60 18.60 Leverage ratio 5.10 5.60 5.00 4.80 4.00 4.20 4.10 4.00 4.60 4.50 Net NPLs/FCC 17.45 12.76 16.86 19.10 7.82 8.81 3.43 2.95 3.49 6.09 Internal capital generation -16.44 -3.26 1.08 -0.40 9.76 9.91 4.08 3.02 2.42 -1.79 Funding and liquidity Loans/customer deposits 92.54 91.34 111.79 109.87 124.18 123.69 116.55 122.41 93.91 96.63 Customer deposits/total funding (excluding derivatives)
70.91 70.08 70.26 69.97 71.48 74.72 65.89 67.14 57.87 58.32
LCR 123.00 136.00 NR NR 140.60 142.60 139.00 120.00 131.00 133.00 NSFR 121.00 121.00 NR NR 130.50 127.90 NR NR NR NR
NR = not reported
LBG: Lloyds Banking Group plc, Nationwide: Nationwide Building Society; SGH: Santander UK Group Holdings plc; Barclays: Barclays plc In accordance with our internal criteria, we have reclassified certain elements of the banks consolidated statutory figures above and in the attached spreadsheets to improve comparability between peers. The main items reclassified as non-operating are US RMBS and PPI provisions, which are treated as non-recurring, non-operating losses
a 2016 data relate to half-year figures ending 30 September 2016. Year-end 4 April
b Fully loaded
c Transitional
Source: Fitch
Banks
The Royal Bank of Scotland Group Plc
April 2017 12
Banks
The Royal Bank of Scotland Group Plc
April 2017 13
Banks
The Royal Bank of Scotland Group Plc
April 2017 14
Banks
The Royal Bank of Scotland Group Plc
April 2017 15
Banks
The Royal Bank of Scotland Group Plc
April 2017 16
The ratings above were solicited by, or on behalf of, the issuer, and therefore,
Fitch has been compensated for the provision of the ratings.
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