Trading update from RBS will test shares rally

A RECENT rally in bank shares will be put to the test this week when Royal Bank of Scotland unveils its first trading update since announcing record losses.

Analysts remain cautious about the pace of the turnaround by the new management team and the effectiveness of the Government's insurance package.

The depth of the recession and its impact on the loan book are expected to point to continuing pressures on the balance sheet, although some analysts are expecting signs of life in the investment banking division.

RBS recently announced 9,000 job cuts as it looks to save 2.5bn over three years. It is now 70% taxpayer-owned and posted a UK record 24.1bn loss for 2008 after mounting bad debts and huge writedowns on its disastrous purchase of ABN Amro in 2007.

The Government's interest in the bank could soar to 95% through RBS's decision to insure more than 300bn in toxic loans with the Treasury's Asset Protection Scheme.

This has increased the public exposure to the bank's potential losses but at least offered some kind of stability to the finances of RBS, which has seen its shares recover from a low base in recent weeks. The shares have risen 75% in the past month.

However, analysts continue to view RBS with some concern. Robert Law, an analyst at Nomura, said in a new circular last week: "RBS still faces the greatest uncertainties and challenges among the UK banks in our view.

"Despite the Asset Protection Scheme, we would still regard the balance sheet as relatively high risk."

The markets will be seeking an update on further asset sales, including the future of the bank's businesses in Asia.

Barclays, which posted a 6.1bn profit last year, has avoided state support and dropped several hints of a strong start to 2009 in recent brief updates to the market.

Despite criticism of chairman Marcus Agius by shareholders angry at the bank's decision to cut them out of last year's Middle East fundraising, its balance sheet has passed Financial Services Authority stress tests.

It has also sold its iShares asset management business to private equity firm CVC to boost its capital position – although it lent the buyer 2.1bn to do the deal.

Credit Suisse analysts expect a strong underlying performance from investment banking division Barclays Capital to drive results on Thursday, which are said to be "well ahead" of the previous year.

Analysts will be wary of any rise in impairments but a contribution to profits may

also come from the lower cost of buying back its own debt in the markets – this factor added 1.66bn to pre-tax profits last year.

The results from stress tests of the 19 largest US banks are expected to be released on Thursday and will include an estimate of the firms' losses.

The news has fixated investors around the world worried about the health of the US banking system.

The Federal Reserve and other banking regulators are conducting a battery of tests to see how the capital cushions of the country's biggest banks would weather an economic downturn that was more severe than anticipated.

The tests have been deemed necessary to resolve doubts about the health of the banking system since it suffered steep losses in the wake of the housing market collapse, which has inflicted the most severe US recession in a generation.

The 19 banks tested, which include Citigroup, JPMorgan Chase & Co and Wells Fargo, hold two-thirds of the assets in the US banking system and more than half of the loans.

The results of the examination will include information on both the aggregate and specific bank holding company levels. It will also disclose estimates of losses for certain categories of loans, and resources to absorb those losses under the more adverse economic scenario, the government source said.

The government has said the examination is not a solvency test, but rather a what-if exercise to help supervisors gauge the need for any additional capital across a range of economic outcomes.

The Federal Reserve said last week that some banks deemed to have too thin a capital cushion will have six months to find private funds, while others may need to accept an immediately infusion of taxpayer money.

Examiners subjected the banks to scenarios in which the economy shrinks by as much as 3.3% this year and in which unemployment reaches as high as 10.3% next year.

The baseline scenario for house prices built in a 14% fall this year, and 4% next year, but the Fed also considered a more adverse scenario of a 22% fall this year and 7% next year.