The Royal Bank of Scotland is facing a slowdown in profits growth due to a weak economic climate and deteriorating outlook for credit quality, according to ING Financial Markets.
In a gloomy assessment of the banking sector, the broker slashed recommendations on Royak Bank of Scotland from “buy” to “hold” and HBOS from “strong buy” to “buy”.
ING analysts said that Abbey National — whose chief executive Luqman Arnold is this week expected to issue another gloomy trading update, which analysts expect will include hefty restructuring charges and goodwill write-downs — remains a “sell”. ING also highlighted a possible Lloyds TSB takeover of the Bank of Ireland because of a lack of suitable deals at home.
Profits made by UK banks surged during the late 1990s but the upswing has peaked and may go into reverse by 2004, said ING.
With Chancellor of the Exchequer Gordon Brown’s pre-Budget statement due on Wednesday, ING analyst Michael Helsby said: “A property crash is one of the biggest risks faced by the banks As the Bank of England has highlighted, falling house prices would hit consumption and employment and, in our view, push the UK into recession.”
Helsby warned: “Insolvencies have been trending upwards and the quarterly number stands at levels not seen since 1994. In addition, there has been a number of high-profile cases such as Marconi, Energis and British Energy that will have caused UK banks pain. The cable, telecoms and energy generators will continue to cause pain in the future.”
The analyst highlighted Royal Bank of Scotland’s exposure to seriously indebted European telecoms companies, including France Telecom, Telecom Italia and KPN.
Should the UK enter recession, he said RBS chief executive Fred Goodwin would need to raise charges for bad debts to £3.5 billion in 2004, up from £991 million last year. In a “moderate landing” scenario the provisions would rise to £2.6bn.
ING forecasts that Royal Bank of Scotland will make a net operating income of £6.6bn this year, saying this should rise only marginally to £6.71bn in 2004 under a “moderate landing” scenario. In a “tin hat” situation (a recession coupled with rising unemployment, a housing crash and mounting bad debts) he said Royal Bank of Scotland’s income would fall to £5.47bn in 2004.
ING predicts total UK bank profits will grow by just 3% in 2003 and fall in 2004 in the event of a moderate recovery. In a tin hat situation he said “profits have most certainly peaked”.
Helsby said Royal Bank of Scotland is more prone to suffer top-line growth pressures in the UK than peers including HBOS, but added that RBS’s US Citizens franchise provides an effective safety valve.
He said: “In RBS’s mature domestic markets, meaningful growth is not going to come via organic means. A key attribute that will differentiate UK banks is an ability to extract value and expand overseas. RBS has demonstrated an ability to do this.”
Regarding barriers to growth in the UK, a Royal Bank of Scotland spokesperson said: “People potentially misunderstand that we are not a monolithic brand like Barclays or HSBC.
“Through brands including Royal Bank of Scotland, NatWest, Direct Line, Tesco Personal Finance, Virgin One, Lombard and Coutts, both customer growth and income growth have consistently beaten expectations. But what we cannot do is comment on prospective forecasts.”
However, Helsby warned that Royal Bank of Scotland’s Spanish partner, Banco Santander Central Hispano, may offload at part of its 8% stake in Royal Bank of Scotland, which would dent the latter’s share price. BSCH is under pressure to realise assets because of its exposure to Latin American economies. The RBS spokesperson said: “We cannot talk on behalf of any of our shareholders.”
Helsby was more positive about HBOS, formed last September from the merger of Halifax and Bank of Scotland.
He said: “We believe that HBOS will perform better than most in a lower volume environment. It is leading the way in terms of competition, has tackled its back book problem and is taking share from the other big four banks in their traditional areas of strength.”
Helsby predicts that HBOS will make net operating income of £3.2bn this year rising to £3.4bn in 2003 and £3.53bn in 2004. Royal Bank of Scotland shares closed on Friday at £15.74 with HBOS at 722p.
This article was published in the Sunday Herald on 24 November 2002