Business context and reporting period
The filing is The Royal Bank of Scotland Group plc’s Form 20-F annual report for the fiscal year ended 31 December 2018, prepared under IFRS as issued by the IASB. The filing is not a standalone fourth-quarter report. The Group provides personal, commercial, private and institutional banking services, with most activity concentrated in the UK and Republic of Ireland. The 2018 reporting period included the implementation of UK ring-fencing, adoption of IFRS 9 and continued wind-down of legacy activities.
Financial performance and position
| Metric | 2018 | 2017 | Change |
|---|---|---|---|
| Total income | £13.402bn | £13.133bn | +2.0% |
| Net interest income | £8.656bn | £8.987bn | -3.7% |
| Operating expenses | £9.645bn | £10.401bn | -7.3% |
| Operating profit before tax | £3.359bn | £2.239bn | +50.0% |
| Profit for the year | £2.084bn | £1.415bn | +47.3% |
| Profit attributable to ordinary shareholders | £1.622bn | £752m | +115.7% |
| Net interest margin | 1.98% | 2.13% | -15 basis points |
| Cost:income ratio | 71.7% | 79.0% | Improved |
| Return on tangible equity | 4.8% | 2.2% | Improved |
| Basic earnings per share | 13.5p | 6.3p | Improved |
Operating profit benefited from lower costs and reduced impairments, although underlying income remained pressured by margin compression, competition and weak NatWest Markets conditions. Excluding notable items, management stated that income decreased 4.8% year on year.
- Impairment losses were £398m, down from £493m, with an annualised ECL loss rate of 12.45 basis points. The Group recorded £101m of additional provisions in the third quarter for UK economic uncertainty.
- Total assets declined 5.9% to £694.2bn, primarily because of lower trading assets and derivatives. Customer loans declined 1.6% to £305.1bn, while customer deposits were broadly stable at £360.9bn.
- Cash and balances at central banks were £88.9bn, down from £98.3bn. Cash and cash equivalents declined to £108.8bn from £122.6bn.
- Net cash flow from operating activities was an outflow of £228m, compared with an inflow of £38.7bn in 2017. Investing cash flow was an outflow of £8.0bn and financing cash flow was an outflow of £6.3bn.
- Common Equity Tier 1 ratio was 16.2%, up from 15.9% on an end-point CRR basis. RWAs declined to £188.7bn from £200.9bn, while the CRR leverage ratio increased to 5.4% from 5.3%.
- Liquidity remained strong: liquidity coverage ratio was 158%, stressed outflow coverage was 154% and net stable funding ratio was 141%. The liquidity portfolio was approximately £197.9bn.
- Total regulatory capital was £44.2bn on a PRA transitional basis. Total MREL loss-absorbing capital was estimated at 30.7% of RWAs.
Material changes versus the prior comparable period
- Operating expenses fell £756m, including a £561m reduction in strategic costs. Excluding one-off items, management reported a £278m reduction in operating costs and a 5.8% reduction in full-time equivalent employees.
- The Group adopted IFRS 9 on 1 January 2018. IFRS 9 increased opening expected credit loss provisions by £616m, from £3.832bn under IAS 39 to £4.448bn, with no restatement of prior-year profit or loss.
- NatWest Markets’ operating loss narrowed materially to £70m from £977m, helped by lower legacy disposal losses, lower costs and a £165m insurance indemnity recovery. Core income declined because of difficult fixed-income, currency and commodity markets, particularly in the fourth quarter.
- Commercial Banking operating profit increased to £1.358bn from £1.108bn, while Private Banking operating profit increased to £303m from £143m. Ulster Bank RoI returned to an operating profit of £12m from a £132m loss, helped by lower costs and the sale of non-performing loans.
- Ulster Bank RoI’s non-performing loan ratio declined from 16.7% to 11.3%, and its loan-to-deposit ratio improved from 115% to 105%.
- The Group completed the main legal and operational work required for UK ring-fencing by 1 January 2019, including transfers involving approximately 4.5 million customers.
- The Group settled the US Department of Justice investigation into historic US RMBS activities. The settlement was approximately £3.6bn, including a £1.0bn 2018 income-statement charge. The Group also made a £2.0bn pension contribution related to ring-fencing.
- HM Treasury sold 925 million ordinary shares in June 2018, reducing its ownership to 62.3%. The Group paid a 2.0p interim ordinary dividend and proposed a 3.5p final ordinary dividend and 7.5p special dividend, subject to shareholder approval.
Guidance, outlook, commentary and risks
- For 2019, management targeted approximately £300m of operating-cost reduction, excluding strategic, conduct and litigation costs, and expected aggregate strategic costs of approximately £2.5bn across 2018 and 2019, of which £1.0bn was incurred in 2018.
- Management expected impairments to increase in 2019 but remain below its through-the-cycle assumption of 30–40 basis points. The Group expected 2019 RWAs of approximately £185–190bn.
- The Group planned to issue £3–5bn of MREL-compliant instruments and approximately £1bn of Tier 2 instruments in 2019, with no planned AT1 issuance. It also expected NatWest Markets Plc to issue £3–5bn of term senior unsecured instruments.
- The medium-term target remained return on tangible equity above 12% in 2020, although the target cost:income ratio below 50% was described as increasingly challenging and subject to downside risk. Management updated its medium-term CET1 expectation to approximately 14% at the end of 2021.
- Key risks include Brexit-related economic, legal and operational disruption; failure to obtain or maintain German, Dutch and euro-payment permissions; cyberattacks and IT outages; conduct, litigation and regulatory investigations; LIBOR and other benchmark-rate transition; credit deterioration; low interest rates and margin pressure; competition and technology disruption; climate-related risks; pension risk; and the potential impact of UK Government ownership and future share sales.
- Contingent liabilities and commitments totaled £126.9bn at year end, including £119.9bn of standby facilities, credit lines and other lending commitments. The filing states that additional litigation, regulatory and customer-redress provisions may be required, potentially in substantial amounts.
- Management assessed internal control over financial reporting and disclosure controls as effective. Ernst & Young issued unqualified opinions on the financial statements and internal control over financial reporting.
Most important facts an investor should verify
- Whether the proposed 3.5p final dividend and 7.5p special dividend were approved and paid, and how future distributions affect capital and pension contributions.
- The sustainability of reported earnings after excluding the DOJ settlement, insurance recoveries, disposal gains, own-credit adjustments and other notable items.
- Progress against the 2019 £300m cost-reduction target, the sub-50% cost:income objective and the medium-term return-on-tangible-equity target.
- Actual credit losses relative to the 30–40 basis-point through-the-cycle assumption, particularly under adverse UK house-price, unemployment and GDP scenarios.
- Completion and ongoing costs of ring-fencing, Brexit contingency arrangements, NatWest Markets transfers and the Alternative Remedies Package.
- Remaining exposure to PPI, GRG, tracker-mortgage, LIBOR, FX, RMBS, anti-money-laundering and other litigation or regulatory matters.
- Future MREL issuance requirements, refinancing costs, credit ratings, liquidity metrics and the effect of IFRS 16 and other regulatory changes on capital ratios.
- The effect of HM Treasury’s 62.3% ownership, potential directed share buybacks and future government sell-downs on governance, share supply and market price.