RBS makes large stride on road to recovery

Royal Bank of Scotland's quest to escape from bottomless perdition received a boost as first quarter profits came in ahead of market expectations.

Group operating profit of £1,184m in the first quarter of 2012 contrasted with a £144m loss in the preceding quarter and even improved on the profit of £1,133m in the corresponding quarter of 2011. More importantly for traders, the figure was well ahead of market expectations (according to RBS) of £900m, though it is easy to feel sympathy for investment analysts who have to make sense of the labyrinthine accounts of Royal Bank of Scotland (RBS).

Thus, the group announced a different operating profit figure - what it called Core RBS operating profit - of £1,667m, up 46% on the fourth quarter of 2011, with the Retail & Commercial businesses chipping in with £903m, down 13% on the preceding quarter, while Markets recovered to a profit of £824m, compared with a loss of £109m in the prior quarter. Non-Core losses were £483m, compared with losses of £1,282m in the prior quarter.

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One off hitsImpairment losses totalled £1,314m, down 33% year-on-year and 22% from the fourth quarter of 2011, with reduced bad debt flows, particularly in UK Retail.

RBS took a £2.46bn hit on the rising value of loan notes it has issued. This is purely an accounting adjustment but it has to be made to reflect the fact that it would now cost a lot more money for RBS to go into the market and buy back all of its debt than it would have done just three months ago.

In the prior quarter, the negative adjustment to fair value of own debt (fvood) had been just £472m while the year before the hit had been £560m, so the hit this time round put a serious dent in paper profits. Compared to that sort of dent, the £43m paid to the government under the Asset Protection Scheme (down from £469m a year earlier) pales into significance, while payment protection insurance costs of £125m were also relatively trivial.

The upshot of these one-off adjustments is a statutory loss before tax of £1,404m, a smaller loss than the £1,798m recorded in the preceding quarter but wider than the £116m loss recorded in the first quarter of last year.

Markets division bounces backOn a divisional basis, the Retail and Commercial division saw operating profit (before impairment charges) sliding to £1,692m from £1,921m in the preceding quarter and from £2,032m the year before. The group's recently reshaped Markets division bounced back with a profit of £826m after losing £52m in the fourth quarter of 2011.

Group income was up 25% to £7,131m from £5,721m in the prior quarter, while expenses rose 9% to £3,984m from the fourth quarter figure of £3,644m.

Balance sheet repairsThe group's Core Tier 1 ratio, which is a key measurement of balance sheet strength, was 10.8%, compared with 10.6% at the end of 2011.

Risk-weighted assets (RWAs), excluding the effect of the Asset Protection Scheme (APS), fell £12bn to £496bn, largely reflecting further asset deleveraging. The group reduced its short-term wholesale funding by £23bn during the quarter to £80bn, which compares with a liquidity portfolio of £153bn. RBS's loan:deposit ratio improved to 106%. The run-off of Non-Core and the consistent elimination of legacy risks continued, with Non-Core funded assets down £11bn to £83bn.

"We are happy with progress in the first quarter though the economic and regulatory backdrop remains tough. RBS continues, markedly, to regain strength and resilience. Our focus is on improving the future for customers and our business whilst ensuring that the bank's past issues are dealt with," said Stephen Hester, Chief Executive of RBS.

Perhaps the best indication of the progress RBS has made is the completion of the repayment of £75bn borrowed under the terms of the government's Special Liquidity Scheme and Credit Guarantee Scheme (CGS); the last CGS repayment of £5.7bn is due to be repaid in May.

On top of that, the bank is to pay out to dividends but not, alas, to ordinary shareholders (yet). Holders of series F, H and series L to T non-cumulative preference shares - hybrid capital instruments in the industry jargon - will receive their due dividends for the second quarter of 2012.

Broker reactionNomura Securities said the results were broadly in line with its expectations. "Restructuring of the balance sheet has continued and was faster than targeted, as might have been expected in this period. We therefore expect limited changes to investor perceptions towards the group on the back of these results. RBS appears to be further advanced in its restructuring than Lloyds," Nomura notes.

"Core profit before tax of £1,667m was below our estimate of £2,118m, with higher losses continuing at Ulster [Bank], while non-core losses of £483m were lower than our assumption of £933m," the Japanese broker said.

Investec, meanwhile, said that "despite optical complexity" underlying first quarter results were broadly as expected. "The headline numbers are predictably grim, Earnings per share -1.4p including FVOOD reversal and other one-off noise, though Operating Profit of +£1.2bn was a £0.3bn beat, mainly due to lower non-core losses," the broker notes, in a note entitled "Hope springs eternal?"

Market reaction to the figures was positive, with the shares rising five-eighths of a penny to 25.23p by the middle of the morning trading session.