The state-owned lender swung to a profit attributable to shareholders of £752mln in 2017, compared to the previous year’s eye-watering loss of £6.9bn.
The bank’s total income for the year rose to £13.1bn compared to £12.5bn a year ago but the net interest margin fell by 11 basis points to 2.86%.
Analysts expected RBS to post an annual loss of £592mln after setting aside further provisions to settle a mortgage-backed securities mis-selling suit with the US Department of Justice.
RBS cuts litigation and conduct costs
But the group cut litigation and conduct costs by £4.5bn to £1.3bn last year, helping to bring operating expenses down to £10.4bn from £16.1bn a year ago and return to an annual profit.
Litigation and conduct costs included a settlement with the Federal Housing Finance Agency (FHFA) over claims it mis-sold toxic mortgage-backed bonds.
RBS set aside another £764mln provision in the fourth quarter, including £442mln towards US mortgage litigation suits from the DoJ and other investigations.
It also made another £175mln provision towards the UK’s payment protection insurance mis-selling scandal.
The bank, which is still 71% owned by the government following its taxpayer bailout a decade ago, has also been accused of mistreating small and medium enterprises under its global restructuring group.
"The problems over questionable behaviour at its now defunct global restructuring group continue to hang over the bank like a bad smell, particularly given the reluctance of the regulator to sanction the release of the report into the public domain," said Michael Hewson, chief market analyst at CMC Markets.
"Provision here was left unchanged at £400mln, though the reputational damage could well be longer lasting raising the prospect of how you value the potential intangible effects of future lost business this episode is likely to cause in the future."
Legacy issues remain
Chief executive Ross McEwan said the number of legacy issues the bank faces has reduced but acknowledged that it remains under investigation by the DoJ.
"The timing of the resolution of this issue is not in our control," he said.
Shares fell 4.3% to 269p in morning trade.
RBS faces a hefty fine from the DoJ in relation to the mortgage mis-selling saga, which is likely to hit 2018 profits. It needs to resolve the issue before it can return to dividends and pave the way for the government to begin selling its stake.
“Until these issues are resolved, investors are likely to remain wary of the stock," said AJ Bell investment director Russ Mould.
Restructuring bears fruit but costs set to rise
However, McEwan hailed the bank’s restructuring into a “simpler, safer and more customer-focused bank”.
On the back of the overhaul, RBS reduced its risk-weighted assets by £228mln last year and strengthened its capital position with the common equity tier 1 ratio rising to 15.9% at the end of 2017 from 13.4% the previous year.
RBS plans to spend another £2.5bn over the next two years on its restructuring, of which £300mln relates to the completion of the State Aid remedy and reintegration of the former Williams & Glyn business into UK Personal & Business Banking. That compares to a previous guidance of around £1bn, excluding the impact of W&G.
RBS was freed from its requirement to sell W&G under the conditions of its government bailout after the European Commission accepted an alternative plan to set up a fund for challenger banks.
Shadows still loom over RBS, says analyst
"The bank’s capital position has improved again, though the prospect of a dividend still hinges on the final settlement with US authorities," said Laith Khalaf, senior analyst at Hargreaves Lansdown.
Khalaf said another big shadow hanging over RBS is the large taxpayer stake, which has to be sold off at some point.
"That selling activity is going to put downward pressure on the bank’s share price, so until it’s materially completed, the market isn’t going to get too excited about RBS.
"Indeed with the price now standing at around half of the government’s breakeven point, the taxpayer’s still going to come out of this nursing a significant loss."