RBS Investment Bank Income Jumps, Amsterdam Picked as EU Hub

(Bloomberg) -- Royal Bank of Scotland Group Plc's better-than-expected performance in the second quarter came from an unexpected source: its investment bank.

Revenue at Natwest Markets, which houses the trading business, increased 17 percent to 472 million pounds ($620 million), beating the forecasts of analysts at Morgan Stanley and Jefferies Group LLC. The firm also said it's picked Amsterdam as its post-Brexit European Union trading hub and was preparing to move 150 jobs to the Dutch city.

The shares rose as much as 5 percent, the most since April, and traded 2 percent higher at 261.4 pence at 10:50 a.m. RBS has gained 18 percent this year in London trading, outpacing Lloyds Banking Group Plc and Barclays Plc in the period, but it remains far below the 502-pence-a-share price of its taxpayer bailout.

Three years into his tenure, Chief Executive Officer Ross McEwan is making progress in turning around what was formerly the world's largest lender, though the firm is still dogged by legacy misconduct charges and the need to settle with the U.S. Department of Justice over its mortgage-bond probe. Managers have pared hundreds of billions of pounds from the balance sheet and closed many of the investment bank's businesses to focus on the U.K. after RBS was bailed out in 2008.

“Our operations here, in the U.S. and in Asia are performing very strongly,” McEwan said about the investment bank on a call with journalists. “It all comes down to focus. We restructured it quite heavily two-to-three years ago to be very focused business on rates, FX and capital markets, and as you focus you do better on what you concentrate on.”

Amsterdam Expansion

The bank's new trading operation in the Netherlands will cost “in the low tens of millions” to set up, with annual running expenses at about the same amount, executives said on the call. RBS needs the unit to maintain access to the EU's single market if London loses passporting rights after Britain voted to leave the bloc last year.

Revenue from trading at RBS surged 19 percent to 445 million pounds, the bank said in a statement Friday. When its own credit adjustments were excluded, income at Natwest Markets overall beat the 325 million-pound estimate of analysts at Morgan Stanley by 45 percent.

Still, there's “much room for improvement” at the securities unit, according to Sandy Chen, an analyst at Cenkos Securities Plc, who has a hold rating on the stock.

The return on equity so far this year is a “comparatively paltry” 2.3 percent with a cost-income ratio of 83 percent in the first half, he said in a note to investors. “The key driver behind RBS's strength is, as always, personal and business banking,” which had a vastly better return of 27.8 percent and a cost-income ratio of 58 percent.

The retail bank posted annualized loan growth of 4.1 percent in the half, ahead of the group's 3 percent target for this year, as U.K. mortgages surged.

Net income in the second quarter was 680 million pounds compared with a loss of 1.1 billion pounds a year earlier, marking a second consecutive quarter of growth. Adjusted operating profit of 1.69 billion pounds beat the 1.04 billion-pound estimate of four analysts surveyed by Bloomberg. Revenue rose 32 percent to 3.6 billion pounds, partly boosted by one-time tax and accounting gains.

“It's our best six-month results since the first half of 2014,” Chief Financial Officer Ewen Stevenson said in an interview with Manus Cranny on Bloomberg Television. “But, we know we've still got the Department of Justice to settle. We would aspire to get that settled this year and if we do that, that could well push us into a bottom-line loss” for 2017. That would mark a decade of annual losses.

Operating expenses dropped by 1.1 billion pounds from a year ago. The company's litigation and conduct costs were 342 million pounds, down from 1.28 billion pounds. Unlike competitors Barclays and Lloyds, RBS didn't increase its provisions for payment protection insurance.

Read More: See how U.K. competitor Lloyds fared in the second quarter

McEwan made some steps forward in the bank's return to normality last month, when the lender agreed to pay $5.5 billion to the U.S. Federal Housing Finance Agency to settle a lawsuit alleging RBS sold faulty mortgage bonds to Fannie Mae and Freddie Mac from 2005 to 2007. RBS, which was rescued during the financial crisis, also gained preliminary approval from the European Union for an alternative plan to boost competition after failing to sell its Williams & Glyn unit, a key condition of its 2008 bailout.

The firm's core Tier 1 capital ratio, a measure of financial strength, rose to 14.8 percent from 14.1 percent at the end of March. The bank has previously said it plans to have a ratio of at least 13 percent at the end of this year, while working to cut 20 billion pounds of risk-weighted assets from its core businesses by the end of 2018 to boost capital.

To contact the reporter on this story: Stephen Morris in London at smorris39@bloomberg.net.

To contact the editors responsible for this story: Michael J. Moore at mmoore55@bloomberg.net, Jon Menon, Elisa Martinuzzi