Goodwin ponders £1bn RBS share buyback

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By Ian Fraser

Published: Sunday Herald

Date: 10 December 2006

BANKING: TRADING UPDATE Analyst predicts 25 per cent hike in dividends as bank shelves acquisition strategy for organic growth

ROYAL Bank of Scotland is expected to deliver a further 25 per cent hike in dividends and a further £1 billion in share buybacks alongside its full-year results on March 1 next year.

James Eden, RBS watcher at Dresdner Kleinwort, believes the moves will cause the Edinburgh-based bank’s shares to climb from around £19.60 to around £23, adding impetus to a recovery in the bank’s share price that was sparked by its bullish trading statement last Wednesday. RBS’s shares became the fastest rising in the FTSE-100 on Wednesday after chief executive Sir Fred Goodwin said its profits would be “slightly ahead” of analysts’ estimate of £9.2bn for the year to December 2006.

Investors also welcomed the fact that RBS said it had more limited exposure to bad debts than many of its rivals. Among other things, Goodwin said the surge in individual voluntary agreements (IVAs) was “not causing any angst in the business”. Eden said: “RBS is generating tons of surplus capital and on March 1 we believe that Fred will announce another 25 per cent dividend hike and another £1bn buyback. He is much more likely to do this than to blow it on another over-priced US acquisition.

“The maths is straightforward – he can afford to do both and still manage down the proportion of hybrid capital within the bank’s tier 1 capital ratio towards 30 per cent.” Hybrid capital is a mixture of cash, derivatives and financial instruments used by some banks to raise their tier 1 capital ratios. Tier 1 (equity capital and disclosed reserves) is seen as the bedrock of a bank’s balance sheet and a yardstick used by regulators such as the Financial Services Authority to gauge banks’ financial strength.

The string of acquisitions made by RBS between 2000 and 2004, most notably US bank Charter One, caused its capital ratios to become stretched, and they only started to recover last year after RBS vowed not to make use of investors’ funds for further big deals. Eden said: “We are excited about the next bumper dividend increase, not because it would increase the intrinsic value of the company, but because it should act as a catalyst to drive the share price towards its intrinsic value.”

Eden, despite being critical of Goodwin last year, has become a big supporter of RBS and has set a target price of £23 on its shares.

Speaking on results day, RBS finance director Guy Whittaker said that its tier one ratio will end the year at 7.5 per cent, creating a platform for further share buybacks. On February 28, RBS said it would buy back £1bn worth of shares (1.6 per cent of its market value) in the current year, and that it will consider further buybacks if the tier 1 ratio is between 7 per cent and 8 per cent. Goodwin said buybacks are on the agenda. “We continue to generate capital beyond the needs of the business.

“So we’ll have some surplus capital and, in looking at what to do with that, I’m sure the board will consider buybacks, [increasing the] dividend or doing nothing. We look forward to presenting the board with a full range of options.” The “do nothing” option can be discounted as it would only make investors suspect Goodwin is building up a war-chest for further acquisitions.

GOODWIN told investors that, while it continues to be vigilant, RBS is not overly concerned about its exposure to bad debts. This was in marked contrast to gloomier updates from HSBC and Barclays earlier last week. He said that bad debts on unsecured loans in the UK “continue to moderate”, that RBS has steered clear of subprime mortgages and had “taken its foot off the gas” — in terms of offering unsecured credit to consumers — earlier than rivals. Goodwin also seemed relaxed about the corporate credit environment, despite the recent warning from Hector Sants, the FSA’s managing director of wholesale business, of a possible collapse in the private equity sector, where RBS is the largest loan arranger in Europe.

Options for boosting RBS’s share price examined in a recent Citigroup note — including a break-up of the group and the acquisition of ABN Amro — were dismissed by Goodwin. He said it would be “a bad idea” to sell any part of the businesses and that “we don’t need to make any acquisitions right now, and we are generating results ahead of expectations on a purely organic basis, and that feels a good place to be”.

However, he did acknowledge that a further weakening in the dollar would weaken profits from its US business, which generates about 28 per cent of overall profits. John-Paul Crutchley, at Merrill Lynch, said: “If the exchange rate stays at $1.97 through next year, then Citizens must grow its dollar contribution by 8 per cent just to keep it flat in sterling terms.”

NEED TO KNOW

THE FACTS: RBS’s annual trading update settled City fears that the Scottish bank was set to go on the acquisition trail once again.

BACKGROUND: The bank’s share price has underperformed for some time. CEO Fred Goodwin stressed the company will seek organic growth.

With spare cash in its coffers, the bank will likely raise its dividend to shareholders and introduce a new share buyback scheme.

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