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Lipstick on your dollar

8 September 2014 By Antony Currie

Royal Bank of Scotland is applying a fair amount of lipstick to its U.S. unit ahead of a planned initial public offering. Citizens Financial is worth up to $14 billion, based on the price range of $23 to $25 a share set on Sept. 8. Like the leaders of its home nation, RBS is painting too pretty a picture of life after independence.

The American bank earned $479 million in the first six months of the year, a third higher than the same period in 2013. That only equates to a return on tangible equity of 7.45 percent. Lenders generally only cover their cost of capital when returns breach 10 percent.

The IPO valuation assumes it should hit that pretty soon: at the top of the price range Citizens would be worth almost 1.1 times tangible book value. The bank even draws a map of how it expects to get there.

Executives estimate that a combination of cost cuts, return of capital and interest-rate increases from the Federal Reserve will add up to 3.6 percentage points to last year’s 5.5 percent return on tangible common equity. Throw in more revenue from elsewhere and the bank will be beating its cost of capital within two to three years.

Those are rosy assumptions. While it’s true, for instance, that Citizens has more capital than most of its regional banking peers, it also failed the qualitative part of the Fed’s stress test earlier this year. The watchdog may not be as keen to allow the bank to buy back stock or raise dividends as management is.

The allocated $200 million of cost cuts does not appear enough to bring the efficiency ratio down to the targeted 60 percent; extra revenue seems to be part of the equation. And one of its models, for interest-rate sensitivity, factors in a 2 percentage-point jump over 12 months. That’s aggressive. Another, assessing the impact of a 1.5 percentage-point increase on net interest income, would yield a 1.6 percentage-point jump in tangible equity returns within three years.

Of course, RBS needs as much cash as possible from the sale, whether to boost capital, pay back UK taxpayers or cover whatever conduct fines are coming down the pipe. But that doesn’t mean prospective Citizens shareholders should give it to them.

This item has been corrected to add a second interest-rate model in paragraph six.


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