Royal Bank of Scotland (RBS) has agreed to pay a fine of £14.5 million to the Financial Conduct Authority to settle charges that when selling retail mortgages in 2012, the bank “failed to ensure that advice given to customer was suitable”.
Of the 164 sales regulators reviewed, only two were found to meet appropriate standards, and in some cases “highly inappropriate” advice was given. While we’re disappointed that RBS seems to have an endless supply of skeletons in the closet, we don’t expect this settlement to affect our fair value estimate rating for the no-moat bank for two reasons: First, the fine is small potatoes for the giant bank – is considerably less than 1% of shareholders' equity.
Second, and perhaps more importantly, while the scandal will further damage RBS’ beleaguered reputation, it is unlikely to be a roadblock to its strategy of becoming a retail- and commercial-focused bank given the U.K. banking conditions. The market is very concentrated – RBS and its top three competitors control about 75% of the retail banking market – and good reputations are hard to come by.
Lloyds Banking Group (LLOY), for example, has absorbed misconduct charges of more than £10 billion over the past several years. We expect misconduct to continue to be a material headwind for all U.K. retail-focused banks, not just RBS.
RBS, formerly a dominant U.K. bank, was undone by its global ambitions, in our opinion. RBS destroyed its narrow economic moat with its reckless acquisition of ABN AMRO at the peak of the market bubble in 2007. The bank was bailed out to the tune of £45 billion by the U.K. government, but has since lost it all, and then some, on dodgy assets and misconduct.
RBS has made considerable progress in its transformation, but still has quite a ways to go. RBS's funded run-off assets, just £34 billion at the end of 2013, are down 90% from their peak, but the group is left with aging computer systems, overly complex product offerings, and a well-deserved reputation for poor customer service.
We think that the additional clean-up costs, estimated at £2 billion annually, will eat up much of the bank's operating profits through 2015, and that income on asset sales will be used to prop up the group's lagging capital ratios – shareholders shouldn't expect to see material capital return until 2016 at the earliest, in our opinion.
