01 March 2006

RBS Looks to Flower Through Organic Growth

FT.com, Jane Croft Retail Banking Correspondent, 1 March 2006

On Tuesday Sir Fred Goodwin stood up before analystsand delivered exactly what the City had been hoping for.

The chief executive of Royal Bank of Scotland announced the bank would buy back up to £1bn of shares and increase its dividend pay-out by 25 per cent.

Sir Fred, who has been accused by critics of being a “deal junkie” said the UK’s second-biggest bank had no plans for large acquisitions and would focus on organic growth.

The move follows 23 RBS acquisitions in the past six years. These included paying £21bn for NatWest, £1.1bn for Churchill insurance, €877m (£597m) for Irish bank First Active and a $1.6bn (£919m) investment in Bank of China.

The pace of deals had prompted some investors to fear RBS was pursuing acquisitions at the expense of shareholder value.

Sir Fred said on Tuesday the focus on organic growth did not signal that RBS had “run out of ambition or ideas”.

“That’s the beauty of the position we are in,” he said. “We have a huge range of opportunities for growth to pursue organically.”

RBS said strong organic income growth provided 70 per cent of the increase in 2005.

It pointed to its corporate markets business, which saw operating profit rise by 24 per cent to £5.2bn. The division also benefited from a 30 per cent reduction in bad debt provisions.

But Sir Fred on Tuesday dismissed suggestions that the bank was too reliant on cyclical corporate banking as a future driver of profit. “We are pleased with the performance but we do not depend on it,” he said.

In Citizens, the US division, profit rose by 47 per cent to £1.57bn. This was partly due to the takeover of US bank Charter One in 2004 – but excluding acquisitions, profit rose by 10 per cent.

RBS also pointed out that it now generates 13 per cent of profit from continental Europe – this has been built up mostly from organic growth.

Mark Thomas, analyst at Keefe, Bruyette & Woods, said: “RBS rightfully highlights the strong organic growth within these numbers.”

An institutional shareholder added: “There is a lot of scope still for organic growth. No one is forecasting large acquisitions for RBS next year and yet analysts are expecting very attractive rates of growth.”

In insurance, which includes Direct Line, profit rose by 5 per cent to £926m affected by an increase in net insurance claims following winter storms in 2005.

Analysts called the 1 per cent growth in retail banking profit to £3bn “pedestrian” and in retail direct, the credit cards business, profit rose by 6 per cent.

One key factor holding back retail banking profit in 2005 has been rising bad debts among over-indebted consumers. Impairment charges rose from £916m in 2004 to £1.18bn.

But Richard Staite, analyst at SG Securities, pointed out that, in future, organic growth might be tougher to achieve in some areas due to the mature UK market.

He said: “Some of the divisions that were high growth in the past, such as retail direct and Direct Line are now looking more mature and facing their own pressures.

“It might be tough to see income growth in the current environment. In the next year or so it might be difficult to see where the positive earnings surprises might come from.”

In 2005, RBS focused on driving up market share in such areas as mortgages and by selling more products to existing customers – it gained 60 per cent more NatWest and RBS card customers in the second half than in the same period in 2004 for example.

However, analysts pointed out that with a bank as diversified as RBS, some divisions would always outperform others at key points in the economic cycle.

Simon Maughan, analyst at DkW, said the market expected 8-10 per cent earnings growth from RBS.

He said: “When you get to banks the size of HSBC and RBS you can make arguments that parts of the business will always expand at the same time as other parts slow.

“In future the capital markets business will slow and there are signs the UK banking business will look better.”

RBS is not the only bank to rely on organic growth for future profit – it has been a main driver behind recent revenue increases at European banks, such as BNP Paribas and Santander.

But having cheered investors yesterday with a share buy-back and dividend increase, Sir Fred will now want them to give the bank far more credit for making the most of its existing operations.