DBRS Confirms the Royal Bank of Scotland plc at BBB (high), Trend Stable

DBRS Ratings Limited (DBRS) has today confirmed the ratings of The Royal Bank of Scotland Group plc (RBS or the Group), the top-level holding company, including its ‘BBB’ Issuer Rating. Concurrently, DBRS confirmed the Group’s Senior Debt & Deposits rating at BBB and renamed it Long-Term Senior Debt. The ratings of The Royal Bank of Scotland plc (the Bank), the main operating subsidiary of the Group, are also confirmed at BBB (high) for the Issuer Rating, and Senior Debt and Deposit Rating, and R-1 (low) for the Short-Term Notes rating. The Trend on all ratings is Stable. The Intrinsic Assessment (IA) for the Bank is BBB (high), whilst the support assessment remains SA3. As a result, the Bank’s final ratings are positioned in line with its IA.

The confirmation of the ratings reflect the strength of RBS’s core retail and commercial banking franchise in the UK, which has experienced minimal, if any, loss of market shares during the Group’s long restructuring period. The ratings also incorporate the Group’s ongoing focus on cost-efficiency, moderate capital position, well-positioned funding and liquidity profile and improving credit quality, which has benefited from the successful deleveraging of Capital Resolution. The ratings also consider the notable challenges still facing the Group in the near-term, particularly to profitability with further restructuring costs and the majority of disposal losses related to Capital Resolution expected by the Group in 2017, in addition to the settlement of mortgage-backed securities litigation in the U.S.

In view of the complexity of the divestment of Williams & Glyn, in February 2017 the Commissioner responsible for EU competition launched an alternative plan for RBS to meet its remaining State Aid obligations. If adopted, this alternative plan would replace the existing requirement to achieve separation and divestment of W&G.

In January 2017, RBS made a number of changes to its legal entity structure to support the move towards a ring-fenced structure. Within the ring-fenced structure NatWest will be the main customer facing brand in England, Wales and Western Europe, and Royal Bank of Scotland in Scotland. RBS International and RBS NatWest Markets will be outside the ring-fenced structure. The ring-fenced banking group is expected to comprise of 80% of RBS’s risk-weighted assets.

RBS’s statutory profitability remained very weak in 2016, with the Group reporting its ninth consecutive annual attributable loss, of GBP 7.0 billion, driven principally by GBP 5.9 billion of litigation and conduct charges, mainly due to mortgage-backed securities litigation in the U.S. and GBP 2.1 billion of restructuring costs. DBRS does, however, note, that on an adjusted basis excluding restructuring and litigation & conduct costs, as well as own credit adjustments, the Group’s core business, Personal & Business Banking (PBB), Commercial & Private Banking (CPB) and Natwest Markets (the Group’s rebranded Corporate & Institutional Banking business), demonstrated gradual improvement in 2016, reflecting both revenue growth of 4% YoY, underpinned by robust new lending, and the Group’s continued progress on reducing costs. In 2016, the Group reduced adjusted costs by GBP 985 million, ahead of its cost-savings plan, and committed to remove a further GBP 750 million in 2017.

DBRS notes that the vote in favour of the United Kingdom leaving the European Union (Brexit) on 23 June 2016 is likely to have a negative impact on the large UK banks. For RBS this impact is most likely to be realised through a deterioration in macroeconomic conditions. DBRS does, however, positively note that RBS’s asset quality continues to improve, benefiting from continued progress in deleveraging non-strategic assets, and improved credit quality across the Group’s core markets of the UK and Ireland. This is reflected in the Group’s impaired loan ratio of 2.9% at end-1Q17, compared with 3.9% at end-2015. RBS’s funding and liquidity position also remained solid in 2016, with the usage of wholesale funding broadly unchanged at GBP 80 billion. This compares favourably to a total liquidity portfolio of GBP 164 billion at end-2016. The Group also reported Liquidity Coverage (LCR) and Net Stable Funding (NSFR) ratios of 123% and 121% respectively at end-2016.

DBRS views RBS’s capital position as moderate, with the Group reporting a fully-loaded Common Equity Tier 1 (CET1) ratio of 14.1% at end-1Q17, well in excess of the Group’s current regulatory minimum of 8.4%, and a fully-loaded leverage ratio of 5.0%. The Group also looks well placed to meet certain future requirements, including minimum requirement for own funds and eligible liabilities (MREL), with RBS reporting an MREL ratio of 24.9% at end-1Q17, in excess of its interim 2020 requirement of 24.0%. Further capital strengthening actions, however, remain a key focus for the Group, taking into account additional charges expected in relation to outstanding legacy issues and the results of the Bank of England’s (BoE) 2016 stress test, which saw RBS reach a low point during the stress scenario of 5.9% following ‘strategic’ management actions, and 6.7% following the conversion of Additional Tier 1 (AT1), meaning the bank not only failed to meet its CET1 hurdle rate before AT1 conversion, but also its systemic reference point hurdle rate after the conversion of AT1.

RATING DRIVERS

Upward pressure on the ratings could arise if the Group finalises its restructuring and successfully resolves the outstanding major legacy issues, while at the same time, improving its earnings, credit profile, and capital position.

Downward rating pressure could arise from higher than expected litigation or restructuring charges or a significant weakening of the franchise or deterioration in earnings, funding, and capital. Potential adverse economic effects of the UK’s exit from the EU on the Group’s risk profile could also exert downward pressure on the ratings.

Notes:
All figures are in GBP unless otherwise noted.

The principal applicable methodology is the Global Methodology for Rating Banks and Banking Organisations (May 2017) and DBRS Criteria: Guarantees and Other Forms of Support (February 2017). This can be found at: http://www.dbrs.com/about/methodologies

The sources of information used for this rating include SNL Financial, Bank of England and company documents. DBRS considers the information available to it for the purposes of providing this rating to be of satisfactory quality.

DBRS does not audit the information it receives in connection with the rating process, and it does not and cannot independently verify that information in every instance.

Generally, the conditions that lead to the assignment of a Negative or Positive Trend are resolved within a twelve month period. DBRS’s outlooks and ratings are under regular surveillance.

For further information on DBRS historical default rates published by the European Securities and Markets Authority (“ESMA”) in a central repository, see:
http://cerep.esma.europa.eu/cerep-web/statistics/defaults.xhtml.

Ratings assigned by DBRS Ratings Limited are subject to EU regulations only.

Lead Analyst: Tomasz Walkowicz, Vice President, Global FIG
Rating Committee Chair: William Schwartz, Senior Vice President, Global Credit Policy
Initial Rating Date: October 27, 2004
Last Rating Date: March 7, 2017

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