RBS shaky quarter points to more cuts

The largely rinsed-out PPI issue continued to linger in the third quarter with a £900m provision linked to compensation and other costs that was at the higher end of the range of expectations. The impact, which wiped out profits in the quarter leaving an $8m loss, is a reminder of how corrosive the twenty-year long saga has been, particularly to UK-focused RBS, which has 89% of its asset base in Britain. More broadly, on the basis of continued PPI ripples in RBS’s quarter, investors will need to reassess how much of an additional aftershock could be felt by other British lenders. Holders of shares in Lloyds, which reports next Thursday, may take RBS news as fair warning.

Yet efficiency has trumped PPI remediation as £27.5bn RBS’s main priority so far in the second half, as swap rates and the yield curve, not to mention Brexit, apply pressure on revenues. A pithier question is how well the group is protecting underlying performance from flak that also included a 44% core income drop at NatWest Markets linked to its rates business. That one-off was responsible for the net interest income miss (£3.5bn was expected in Q3; £2.01bn was reported).

Yet, with the net interest margin (NIM) also falling 5 basis points (bp) quarter-on-quarter, RBS’s formula for underlying stability still looks incomplete. After all, the main driver of weakening NIM is actually an increasingly fierce battle over residential mortgage market share as rates trend weaker.

In other words, RBS may need to double down on cost cuts, and that points to further potential headcount reduction. Such thinking hasn’t been highlighted in the group’s Q3 report. In the context of the negative PPI and NatWest surprises, a 19% stock advance on Brexit deal progress since 11^th October is being trimmed on Thursday and looks set to be reduced further into the year end.

RBS’s key Q3 success was continued retail lending and deposit growth, whilst excluding a 50bp PPI hit, Tier 1 ratio at 15.7% portrays stable capital strength that keeps dividend plans on track, though not much better. New CEO Alison Rose, a 30-year RBS veteran, will be more familiar than most with where the remaining fat lies.