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More 'heavy lifting' on cost cutting ahead for RBS, McEwan warns

Royal Bank of Scotland Group Plc reported its first positive full-year result in a decade Feb. 23, but CEO Ross McEwan warned that bumps in the road still lie ahead, and investors were unimpressed, pushing the lender's shares down 4.4% and making them the day's biggest faller in the benchmark FTSE 100.

"Despite our good progress on simplifying the business, we still are far too complex," McEwan told analysts after RBS booked its first full-year profit since being bailed out at the height of the global financial crisis. RBS reported a full-year profit of £752 million, compared to a loss of £6.96 billion for full year 2016.

The bank announced in January that it planned to sell its headquarters in Bishopsgate in the City of London, as part of an ongoing cost-cutting drive. It cut its workforce by 6,600 full-time employees in 2017, an 8.5% reduction over the year.

The staff cuts helped pull adjusted operating costs down by £810 million, or 9.6%, in 2017, compared with a £985 million reduction in 2016. Its cost-to-income ratio on an adjusted basis — stripping out factors including litigation and conduct costs — declined to 58.2% in 2017 from 66.0% in 2016.

But the lingering complexity means that more "heavy lifting" remains to be done on the cost-cutting front in 2018, McEwan said. Costs will continue to fall in 2018, although at a slower pace than in the previous year, he added.

The bank has a 2020 target of pushing the cost-to-income ratio below 50%, although it said increasing levels of spending on investment and innovation mean that it will no longer offer absolute cost base guidance.

McEwan declined to elaborate when asked about the prospect of further branch closures, saying only, "We have to keep taking cost out, but we won't say more about branch closures." RBS came under fire from consumers and politicians after it announced in December 2017 that it was to close 259 branches, including 62 RBS branches and 197 National Westminster Bank Plc branches.

Ring-fence warning

McEwan also warned that the bank would face some higher costs as a result of the U.K.'s requirement that lenders ring-fence retail operations, as well as preparations for Brexit and conduct-related charges.

The bank still faces a heavy fine from the U.S. Department of Justice related to allegations of misselling of residential mortgage-backed securities in the years leading up to the financial crisis. RBS said in 2017 that it had put aside $3.3 billion in provisions to cover the potential fine.

It is also under intense scrutiny from the U.K. Treasury select committee, which recently received a report from the Financial Conduct Authority into alleged abuses of clients in RBS' turnaround unit, the Global Restructuring Group.

"We are cautious on how quickly higher conduct costs will tail off. Away from the DOJ settlement, we expect significant conduct costs in 2018 and 2019, before tailing off to a lower level," McEwan said.

The bank also anticipates restructuring costs of £2.5 billion across 2018 and 2019, according to its earnings release.

Laith Khalaf, senior analyst at Hargreaves Lansdown, said in a Feb. 23 note that RBS had had "a tricky but momentous year," but he called attention to the large fine still looming over the bank.

"RBS has broken its 10-year duck and managed to squeeze out a profit in 2017, thanks in large part to a big fall in litigation and conduct costs. This is a stay of execution rather than a pardon, however, because the bank is still facing a multibillion-dollar penalty from the U.S. Department of Justice, which is now going to impair profitability in 2018," he wrote.

The bank's top line is "moving in the right direction" as costs reduce, but there is heavy spending ahead as the bank ramps up its restructuring efforts, Khalaf added.