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Overview
RBS was one of the largest banks in the world before the financial crisis of 2008. Its
£2-trillion balance sheet was bigger than most banks at the time.However, the bank has significantly changed after the crisis.
The bank has shrunk considerably in size - moving away from a business model that predominantly focused on investment bank operations to one that depends almost completely on traditional loans-and-deposits banking.A bulk of the reorganization started in 2012, when the bank slashed its investment banking activities.The large-scale reorganization plan was triggered by conditions imposed on RBS as a part of its bail-out at the peak of the recession as well as stricter regulatory changes in the wake of the downturn.
In this dashboard, we analyze how RBS's revenues and profits would have trended it had maintained a full-fledged investment bank over the years. We focus on trends after 2012, as that is when the bank reorganized its investment banking operations.
Note: To calculate potential revenue growth and investment banking margins, we have taken the historical average of changes in these figures for 4 major European banks (Barclays, Credit Suisse, UBS and Deutsche Bank) over the same time frame
Understanding Trends In Average Investment Banking Margin and Revenue Growth For RBS's European Peers
To paint a picture of how RBS's investment banking business would have fared over the years, we first determine how its 4 European peers actually performed. This is the benchmark we use to extrapolate RBS's investment banking revenues and profits
Combined Investment Banking Revenue Of 4 Major European Investment Banks
Implied Average Revenue Growth
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The average revenue growth of other European banks over 2012-2018 ranged from 6.2% in 2012 to -14% in 2016. We assume that the RBS 's IB revenues would have moved in tandem with the historical average of other banks.
Average Investment Banking Margin
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Similarly, the average IB margin for these banks has ranged from 23% to 5.6% over the same time-frame.
Understanding How Similar Trends In RBS's Investment Banking Operations Would Have Affected Its Revenues and Profits Over The Years
RBS's Total Revenue Would Have Been Much Higher
Total net revenue
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Investment Banking as % of Total revenue
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If RBS had not reduced its IB activities and grown at the pace seen for other European banks, RBS's revenue in 2018 could have been £18 billion - almost 35% higher than its actual revenue of £13.4 billion
Moreover, the contribution of IB to total revenue could have reached 33% as opposed to just 11%
RBS's Operating Income Would Have Remained Higher Over The Period
Earnings Before Taxes [ A - B + C ]
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Total net revenue [ A ]
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Total noninterest expense [ B ]
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Credit Loss [ C ]
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As RBS's IB margin would have been higher, it would have helped the bank generate higher profits
Details about how we arrive at our forecast for RBS's Revenues and Profits for the scenario when investment banking operations had a trend comparable to peers is available in a separate dashboard:
How RBS's Pre-Tax Profits Could Have Received A Boost Due To The Continuation Of IB Activities?
Moreover, the high-margin IB business would have also helped RBS's operating margin nudge ahead
RBS's IB margin could have been much higher, providing the bank's overall EBT margin an upward push.The bank's EBT margin in 2017 could have been 22% as opposed to just 17% Notably, though, the bank's decision to cut down its trading activities is bearing fruits. RBS's actual EBT margin in 2018 was 25% while if the bank wouldn't have cut down its IB business, the margin could have been lower at 24%And the gap would have widened going due to weaker economic conditions in Europe, and the growing dominance of U.S. investment banks
Actual IB Margin for RBS
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Scenario-Specific IB Margin for RBS
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Implied EBT Margin for RBS
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RBS's net income would have been higher - resulting in higher EPS figures
Higher revenues coupled with higher margin would have helped RBS generate more profits.As a result, the bank's net income could have been higher-providing an upward pull to the EPS.RBS's EPS in 2018 could have been 20 pence per share - almost 60% higher than its reported EPS of 13 pence per shareBut as highlighted above, the benefits would have reduced in 2019, with the EPS figure being 15% more than our current forecast if the trends for other European investment banks was replicated for RBS
EPS [ A / B ]
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Net income [ A ]
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Average diluted common shares issued and outstanding [ B ]
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As a result of higher profits, RBS's share price could have been worth $8
Additional revenues coupled with higher operating profits would have provided an upward push to the EPS.As a result, we believe RBS's share could have been worth $8 as opposed to our current price estimate of under $7
Note: The share price formula has a factor of 4, as each U.S. ADR represents 4 common shares
RBS' Share Price = [ A x B x C ] x 4
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EPS [ A ]
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P/E Multiple [ B ]
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Exchange Rate [ C ]
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Conclusion: With The Benefit of Hindsight, RBS's Decision To Cut Back Its Investment Banking Activities Looks Like The Right Move
Although RBS's decision to cut down its trading operations adversely impacted the bank's performance in the earlier years, the bank is starting to enjoy its benefits now.One-time restructuring charges and impairment costs had an adverse impact on the bank's bottom line. However, the bank's focus on the higher margin retail business is helping the bank churn out more profits than it would have if it were to continue with IB operations.Although RBS's revenues and EPS figure would have been higher if it retained full-fledged investment banking operations, the narrowing gap between actual and potential revenues indicates that the current model will be more profitable going forward. Also, the increased regulatory requirements linked to a bigger investment banking arm would have raised RBS's capital requirements considerably - weighing on the bank's return on equity. This in turn would have very likely made the bank's return to the private sector a much slower process.Taking everything into account, the imposed focus on retail banking and the subsequent exit from many investment banking activities looks like the right decision for RBS in the long run
Related Analysis
RBS vs Barclays: A Detailed Comparison
RBS Valuation: Expensive Or Cheap?
RBS Revenues: How Does RBS Make Money?
Will RBS See Continued Loan Portfolio Declines In Q1?
Can RBS Sustain Its Profitability In Q4?
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