Why RBS applause is muted

Little credit

Investors are barely crediting Royal Bank of Scotland’s solid third quarter. Its shares hardly tarried 3% higher on Friday before easing quickly to a more modest gain. That’s despite firm results in a mixed reporting season for UK banks so far. Adjusted income exceeded guidance with a 5.6% rise to £3.16bn. £871m operating profit also surprised some 25% to the upside for a third successive quarter of improvement. Furthermore, the group is improving its once parlous capital position more briskly than expected. RBS’s Key Common Equity Tier 1 capital buffer, part and parcel of exacting regulatory demands, increased 70 basis points to 15.5%, cementing one of the group’s few leading positions among rivals that have recently averaged around 14%. Investors should ordinarily be pleased about firming capital, as it points to a smooth transition to the more stringent capital regime the Prudential Regulatory Authority has been signalling of late.

‘Pocket of risk’

In fact, part of Friday’s muted shareholder applause may be linked to the regulatory burden. The BoE wants to see higher provisions for potential losses on consumer credit, reacting to evidence of a “pocket of risk”. Sure enough, loan losses have risen across large lenders in recent months, including RBS. The group’s UK loan impairments rose £40m in Q3, driving overall impairments £7m above City forecasts to £143m. RBS, which has yet to make an annual profit since being saved by the State following the financial crisis, would almost certainly struggle more than even the most exposed lender to the domestic loan market, Lloyds, if UK borrowing begins to fray badly.

Fragile

The Brexit backdrop adds another dimension of consumer risk. Finer measures of RBS profitability, like Return on tangible Equity (RoTE), whilst improving, remain in low single digits, betraying the still fragile health of a group which could relapse if economics truly sour. Provisions for legacy conduct exposure, for example Global Restructuring Group fallout and U.S. Dept. of Justice cases, look just about adequate at the moment. The legal front is of course the least predictable aspect of banking. With RBS shares outperforming UK rivals this year and price approaching book value signs of curbed investor enthusiasm make sense.

A closer look at RBS’s share price chart technicals reveals one interpretation of the stock’s contained advance in reaction to a successful quarter: Friday’s high at the time of writing was just short of c.292p resistance that was formerly support—late in 2015 and early in 2016. It looks like shareholders are cautious about chasing the shares into the level on the strength of RBS’s Q3 results alone. Trade beneath 8^th September-20^th October rising trend, also suggests a cautious stance, although the longer-lived rising trend since the Brexit vote is intact. Some support can also be expected the rising line across peaks since early 2016. But for the moment, this modest stock looks to have exhausted potential in its most recent up leg, judging by the RSI momentum tool. Therefore, significant further gains towards likely challenges near the important 61.8% (313p) retracement of late Feb 2015-July 2016 decline, require better justification. Below 50% (281p), on which the stock has perched on Friday and if a consolidation band tailed by 270p fails to hold, 240p would be in view, the first step of RBS’s early September-mid October advance.