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How long can Royal Bank of Scotland keep rolling with punches as Italy turmoil threatens new European crisis?

The 2008 rights issue and bail-out mark a financial concussion from which shareholders have yet to recover.
businesman punched in the face
How much punishment can RBS shareholders take?

Investors holding any portion of Royal Bank of Scotland Plc’s (LON:RBS) publicly traded shares during the past decade will have learned to roll with the punches.

The barrage of catastrophes in the past ten years has included the sub-prime collapse, credit crunch, partial-nationalisation, chief executive departures, scandal and censure.

April marked the ten year anniversary of RBS’s contentious £12bn rights issue which preceded the £45bn taxpayer bailout in October 2008. It was a financial concussion from which the bank has yet to recover.

Now, in 2018, the RBS has only recently reached a settlement with the US authorities over its role in market-wide lending practices that created the conditions for the financial crisis.

READ: The timeline to Royal Bank of Scotland’s decade of woe

It is, meanwhile, being suggested to the market through the media that the UK Government is now preparing to reduce its ownership stake, with a £3bn share sale to divest 10% of the company and trim the Treasury’s current position from around 70%.

A supportive narrative could be spun to suggest that the divestment represents some sort of milestone in RBS’s stabilisation and recovery.

And, it is true that RBS this April saw its first post-crisis annual profit.

But, to purport any form of victory in the upcoming share sale would belie not only the massive loss which will be realised on taxpayers’ ‘investment’ in the bank but also underestimate the risks and uncertainties that the bank currently faces.

Celebration would be quite premature, especially as Brexit is now supposedly less than twelve months away and new potential crises are looming in Europe’s financial system.

New crisis in Europe

Europe’s banks are facing fresh disruption not least due to the prospect of Italian political upheaval which could trigger what unimaginative commentators are referring to as ‘Italexit’.

Brexit, despite its obvious inherent uncertainties, has actually fostered something resembling unity among most within the eurozone and its member states.

The single currency area did not translate Britain’s retreat towards nationalism as the immediate divisive trigger that some had predicted.  Instead, the complex, unchartered and evidently expensive negotiation processes have appeared to discourage other European nations from looking to the exit door.

Italy, however, is struggling with a level of public disquiet last seen in the lead up to Greece’s economic crisis.

Like Greece, Italy is overstretched with debt and the burden of austerity is weighing heavily on the electorate.

March elections saw power swing towards two radical anti-establishment and anti-Europe parties, the 5-Star Movement and the League, which benefitted from a heavy turnout.

It has left a political stalemate in the country, which is now without a workable government ahead of a second wave of elections now slated for July.

It is alleged, by the traditional political establishment, that the two populist parties have conceived a plan to steer Italy out of the euro, though Five Star chief Luigi Di Maio and League leader Matteo Salvini have both rebutted such claims.

In the meantime, uncertainty is the only thing that’s certain and, naturally, given the country’s sizeable debt pile (which in 2017 equated to around 120% of GDP), there are now fears for Italy’s international credit rating.

Any further deterioration in perceived credit worthiness is expected to further exacerbation the situation, through credit rating downgrades.

Remember, it was the collapse in confidence of international investors that arguably had the most profound impact in the Greek debt crisis.

Commentators estimate that the potential Italian crisis is a much bigger problem for Europe, as Italy’s economy is about 10 times larger than its neighbour across the Adriatic. They say it raises fresh existential questions for the eurozone and the single currency.

Banking stocks slide, adding another layer of doubt for RBS investors

Italian financial institutions have lost around a fifth of their value in recent trading sessions as the country’s interim prime minister Carlo Cottarelli has failed to form a stop-gap government.

Across Europe, meanwhile, the whole sector has lost around 9% in terms of market capitalisation.

If you exclude the UK bank’s knife-fall in the days following the 2016 Brexit vote, the sell-off is among the sharpest since the days of the financial crisis.

In a sector note, Jan Wolter, banking analyst at Credit Suisse, said: “Price action has been material and suggests the market is close to pricing an Italexit.”

He added, however, that: “Credit Suisse economists argue that an Italexit is unlikely, as a referendum on leaving the euro is not an option, according to the Italian Constitution.”

The analyst, nonetheless, noted a number of key risks for European banks - namely wider lending spreads which would potentially “de-rail” guidance on funding costs; a potential for reductions in fee income due to capital market volatility; and the potential for anticipated interest rate rises to not materialise should the ECB need to extend its support.

Across the whole sector, Wolter sees Lloyds Banking Group Plc (LON:LLOY) among the ‘top picks’ for Credit Suisse.

For RBS, rated ‘neutral’ by Credit Suisse, the Italian uncertainty adds yet another layer of doubt for investors as the part-nationalised bank continues to restructure and rebuild.

The task is further destabilised by the fact that one of the architects of RBS’s rebuild, chief financial officer Ewan Stevenson, has today announced his resignation.

Despite being among the favourites to succeed chief executive Ross McEwan, Stevenson has decided to leave RBS to take an alternative position elsewhere.

Boardroom reshuffling will now be another focal point for investors who will also be watching to see how easily RBS’s market valuation can absorb the influx of government held equity, once the speculated treasury share sale is executed.

With so much going on, investors can be forgiven for feeling punch-drunk.

And whilst the stake sale may arguably be framed from the point of view of Philip Hammond’s treasury taking a knee, there are still many more rounds to go for RBS stakeholders.

Investors that still feel sufficiently tenacious will need to keep a high guard as they continue their rope-a-dope approach to ‘value investing’.

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