Royal Bank of Scotland Group (LSE: RBS) (NYSE: RBS.US) cheered investors this morning with news that the bank may not lose as much money on some of its bad loans as expected.
RBS shares rose by around 4% when markets opened, thanks to news that the bank expects to release impairments worth around 500m during the third quarter.
What does this mean?
Todays news mostly relates to the bad mortgage loans held by the RBS bad bank, RBS Capital Resolution (RCR).
Many of these loans relate to the Irish property market, which is currently booming. This means that the value of the properties the RCR loans relate has risen.
As a result, RBS expects lower default rates on these loans, and has reduced the impairment provisions on the loans by around 300m during the third quarter.
RBS also said that it managed to sell 9bn worth of legacy debt securities for a loss of just 200m. This is actually good news, as it removes a load of toxic assets from the banks balance sheet; this should result in an increase in the banks Common Equity Tier 1 Ratio, a key regulatory measure.
Not a cash gain
Although todays news is positive for RBS, its important to remember that these are not cash gains.
Impairment provisions are expected future losses from assets, such as loans, which may not be repaid in full. When an asset is impaired, the impairment provision is entered into the banks income statement as an expense.
If the impairment is reversed, this shows as income so while todays news should boost RBSs reported profits, it wont help the bank to fund a dividend.
What about real profits?
RBS said today that Corporate & Institutional Banking revenues had been disappointing, but didnt mention its much larger Personal & Business or Commercial & Private Banking divisions.
My suspicion is that profits from these divisions could be fairly flat in Q3, but this isnt necessarily bad news, as RBS is already reasonably profitable: cost-cutting and winding down its bad bank are RBSs most important goals.
Buy RBS on todays news?
Im broadly bullish on RBS over the medium term, but in my view, todays news has left the banks shares looking quite fully valued, with a forecast P/E of just over 12.
Given that there is little chance of meaningful dividend until 2016, I think thats enough, for now, so Id rate RBS as a solid hold.
I reckon there are better buys elsewhere in the banking sector.
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Roland Head has no position in any shares mentioned. The Motley Fool UK has no position in any of the shares mentioned. We Fools don’t all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors.
