Is Royal Bank of Scotland Group plc a buy after it takes £3.1bn hit?
For investors in RBS(LSE:RBS), it sometimes feels as if it's a case of one step forward, two steps back. In fact, the part-nationalised bank continues to struggle to move on from the credit crunch. Today, there were more legacy issues in the form of a provision of £3.1bn. This concerns various investigations and litigation matters relating to the bank's issuance and underwriting of US residential mortgage-backed securities. Despite this, its shares are up over 4% today. Is now a good time to buy?
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Legacy issues
Although today's announcement wasn't a surprise, it's nevertheless yet more disappointment for the bank's shareholders. The £3.1bn provision takes the total aggregate of such provisions to £6.7bn and in reality, there's a chance they will rise over the medium term. Of course, this eats into profitability and the valuation of the bank. Today's provision has the effect of reducing RBS's tangible net asset value per share by 27p to 311p. It also reduces its 2016 common equity tier 1 (CET1) ratio by 1.35% to 13.6%.
Looking ahead, the bank's overall profitability is likely to be hurt yet further thanks to the mistakes it made a decade ago. How long this will last is a known unknown, but it seems likely that there will be further provisions during the course of the next couple of years. This could hold the bank's share price back, although judging by today's share price rise it seems as though investors have already priced-in such challenges.
Growth potential
Despite reducing RBS's net asset value, today's provision leaves the bank's shares on a highly enticing valuation. For example, they have a price-to-book (P/B) ratio of around 0.5. This indicates they could double and still trade at what's a relatively attractive valuation. Evidence of this can be seen when RBS's valuation is compared to that of banking peer HSBC(LSE: HSBA). The latter has a P/B ratio of 0.7, which indicates that its sector peer is undervalued.
RBS has upbeat forecasts and despite the legacy issues it faces, its underlying performance continues to improve. For example, in 2017 it's expected to record a rise in earnings of 19%, followed by further growth of 17% next year. This puts it on a price-to-earnings growth (PEG) ratio of only 0.7. By contrast, HSBC is forecast to report a rise in its bottom line of 6% this year and 7% next year. This means it has a PEG ratio of 1.7 which, while still impressive, is far less so than that of its sector peer.
Today's news may be disappointing for investors in RBS and more bad news could lie ahead in this regard. However, it's fundamentally cheap, has a sound strategy and is expected to improve on its underlying performance over the next couple of years. Therefore, while HSBC may be a less risky option, RBS has the scope to deliver higher capital gains over the medium term.
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Peter Stephens owns shares of HSBC Holdings and Royal Bank of Scotland Group. The Motley Fool UK has recommended HSBC Holdings. We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors.
