FINANCIAL INSTITUTIONS

ISSUER COMMENT4 August 2017

Contacts

Daniel Forssen,CFA 44-20-7772-1553Associate Analystdaniel.forssen@moodys.com

Alessandro Roccati 44-20-7772-1603Senior Vice Presidentalessandro.roccati@moodys.com

Laurie Mayers 44-20-7772-5582Associate ManagingDirectorlaurie.mayers@moodys.com

Nick Hill 33-1-5330-1029MD-Bankingnick.hill@moodys.com

The Royal Bank of Scotland Group plc2Q17 results: Higher revenues, cost reductions and lowercredit impairments return RBS to profit; capital strengthened

In Q2 20171, The Royal Bank of Scotland Group plc (RBS, LT senior unsecured Baa3 stable)reported a net profit of £680 million relative to a loss of £1.1 billion in the prior year. Thiscorresponds to an annualised after-tax return on risk-weighted assets (RWAs) of 124 basispoints (bps), compared to negative 174 bps a year earlier, and an annualised after-tax returnon equity of 6.5% (2Q16: negative 9.2%). Pre-tax profit (adjusted basis) improved to £1.7billion from £716 million the year earlier. RBS’s improved quarterly performance was drivenby higher reported revenues and lower operating expenses, and lower credit impairments.Capital strengthened in the quarter, bringing the Common Equity Tier 1 (CET1) ratio to 14.8%(+70 bps) supported by a reduction in risk weighted assets (RWAs). We view these resultsas positive, but credit neutral. In June, we upgraded RBS’s senior holding company ratings,reflecting our expectation that the bank’s ongoing progress in its complex restructuringexercise, will reduce non-core operations to a small residual and will begin to result in thegeneration of more stable and sustainable earnings.

The operating profit in the quarter included £452 million of adverse significant items (Q22016: £1.4 billion net adverse items) including £213 million of restructuring costs (Q2 2016:£392 million) and £342 million of litigation and conduct costs (Q2 2016: 1.3 billion).

Higher revenues, cost reductions and lower non-core losses supported results.Adjusted revenue improved across all main businesses and non-core losses reducedsubstantially. RBS achieved a further £216 million in net cost reductions and stated it is ontrack to meet its £750 million 2017 cost reduction target (66% met in first six months).Cost reductions in the quarter were seen across non-core and core businesses (particularly inCommercial Banking). Lower credit impairments also supported results.

End-2017 de-risking target met: RBS further reduced its Capital Resolution legacy assetportfolios by £3.9 billion to £26.6 billion RWAs in the quarter (Exhibit 1), which includes £7.4billion of Alawwal2 related RWAs. RBS has already met its end-2017 target of £15-20 billionof RWAs in capital resolution excluding Alawwal and expects to fold the non-core unit intothe core business in Q4 2017. RBS expects to incur the majority of its remaining non-corebudgeted disposal costs of £800 million in the remainder of 2017 (Q2 2017: nil).

Capitalisation significantly strengthened. Further RWA reductions in the non-core book,managed reductions in the core book and the profit for the quarter led to 70 basis point (bps)improvement in RBS’s CET1 ratio to 14.8%, solidly above the UK peer median. We expectRBS to maintain this higher level of capitalisation in the face of short-term headwinds oflitigation matters and restructuring. RBS’s capital position is currently one of the strongest

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among UK and global peers with a CET1 ratio of 14.8% at end-June 2017 relative to a UK peer median of 12.6% at the same date(Exhibit 1 and 2) . RBS’s leverage ratio increased by 10 basis points in the quarter to 5.1% , well above the current 3% minimumregulatory requirement and well above the UK peer median of 4.2% at end-June 2017.

Exhibit 1

Common Equity Tier 1 (CET1) ratio and Tier 1 Leverage Ratio relative to UK peers and Global Investments Banks median, end-June 2017

14.8%

13.5%13.1%

13.1%12.1%

10.9%

5.1% 4.8%4.5%

5.5%

3.9% 3.8%

0.0%

3.0%

6.0%

9.0%

12.0%

15.0%

18.0%

Royal Bank of Scotland Lloyds Barclays GIBS median* Santander UK** HSBC Bank plc

CET1 Ratio Tier 1 Leverage ratio Median UK peers CET1 ratio (12.6%) Median UK peers leverage ratio (4.2%)

*GIBS (Global Investment Banks) – Moody’s peer group of 12 banks **Leverage ratio at end-March 2017Source: Company results presentations and financials, Moody's

RBS provided a first time estimate of 1 July 2017 IFRS9 impact, expecting it to be modestly capital accretive. The estimatessuggest a £0.5 billion increase in loan loss provision and a £1.0 billion mark-to-market gain on certain loan portfolios. On a capitalbasis, CET1 is estimated to improve 30bps, reflecting a reduced expected loss deduction.

Credit risk further improved, supported by non-core run off and decreased problem loans in several core segments. Thegroup’s non-performing loan (NPL) ratio3 declined to 2.8% at end-June 2017 from 3.1% at end-2016.

RBS settled in July with the Federal Housing Finance Agency (FHFA) for $5.5 billion (£4.2 billion), with a negative impact of £151 millionin the quarter, leaving £2.9 billion reserves to cover the outstanding US Department of Justice and other RMBS-related litigations. Nomaterial development has occurred in relation to the DOJ RMBS investigation. RBS booked no further payment protection insurance(PPI) provisions in the quarter in contrast to its major UK peers some of which recorded several hundred million pounds sterling ofprovisions in Q2 2017; remaining PPI provisions stand at £1.1 billion .

The group's funding and liquidity position continues to remain strong. RBS reported a Basel III Liquidity Coverage ratio of 145% (beforepayment of FHFA settlement) and a Net Stable Funding Ratio of 123% at end-June 2017 . Liquid resources at £178 billion were wellin excess of £88 billion wholesale funding. Operating profits by main line of business (All comparisons are made to Q2 2016, unlessotherwise indicated).

This publication does not announce a credit rating action. For any credit ratings referenced in this publication, please see the ratings tab on the issuer/entity page onwww.moodys.com for the most updated credit rating action information and rating history.

2 4 August 2017 The Royal Bank of Scotland Group plc: 2Q17 results: Higher revenues, cost reductions and lower credit impairments return RBS to profit; capitalstrengthened

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Exhibit 2

Reported quarterly pre -tax profits by business line

-5,000

-4,000

-3,000

-2,000

-1,000

-

1,000

2,000

Q2 2016 Q3 2016 Q4 2016 Q1 2017 Q2 2017

£ m

illio

n

UK PBB Ulster Bank Commercial Banking Natwest Markets Capital Resolution Other

Note: UK PBB denotes UK Personal & Business Banking, CIB denotes Corporate & Institutional Banking, Results for Private Banking are included in ‘Other’Source: Source: RBS’s Excel data supplement

The UK Personal & Business Banking (UK PBB) division, one of the group’s key credit strengths, reported an operating profit of£603 million relative to £24 million in the prior year. The improvement was driven primarily by modest litigation conduct costs ( £400million of PPI provisions in 2Q16)). Net interest income grew by 3%, reflecting higher lending volumes and deposit re-pricing, partiallyoffset by lower mortgage margins and a decline in current account hedge returns. Net interest margin of 2.92% was down 20 basispoints (bps) compared to 3.12% in Q2 2016 and down by 9 bps relative to Q1 2017. The positive lending growth trend continued in thequarter (gross l ending up 2% in the quarter versus end-March 2017), driven by higher mortgage lending (up 2%) and business bankinglending (balances up by 3%). Adjusted operating expenses were marginally lower (down 11% to £697 million), reflecting lower staffcosts and others costs, as RBS progresses in reducing its cost base.

Ulster Bank RoI (Ulster Bank Ireland DAC, LT deposits Baa2 stable, BCA ba1) generated an operating loss of EUR 20 million, a narrowerloss from EUR 69 million in the prior year. The result primarily reflects lower litigation and conduct costs, which were partly offset byEUR 15 million of credit losses relative to a reversal of EUR17 million in the prior year. Net interest income was flat, with net interestmargin up 6 bps to 1.60% (vs 1.54% in Q2 2016). Adjusted operating expenses increased by 11%, largely reflecting lower accrualreleases and a higher Republic of Ireland (A3 positive) bank levy.

The Commercial Banking (CB) division, reported a strong 92% increase in operating profit to £406 million. Higher revenues, lowerstaff costs and lower impairment losses drove the improvement. Net interest income increased by 8% driven by deposit volumegrowth and re-pricing actions, despite net interest margin weakened by 5 basis points to 1.73%. Adjusted operating expenses decreasedby 14%, reflecting primarily reduced headcount as RBS progressed on its cost savings initiatives. Adjusted cost-income ratio was 46.1%compared with 49.7% in Q1 2017. Gross loans decreased 2% since end-March 2017 to £98.8 billion, in line with the group strategy.Notably, asset and invoice finance lending increased 6% since end-March 2017 to £15.1 billion.

Natwest Markets recorded an operating profit of £88 million, down 19% relative to the same period last year. The decline primarilyreflected a negative movement in own credit adjustments. On an adjusted basis, operating profit increased 62% to £154 million. Theimprovement was driven by higher revenues with improved results in all product lines: Financing (+102%), Rates (+9%) and Currencies(+5%). Adjusted operating expenses rose by 3% to £317 million on higher investment spend, and, combined with stronger income, ledto a decrease in the division adjusted cost-income ratio to 67% (Q2 2016: 76.5%). This compares to a 2020 divisional target of circa55%, which RBS expects to meet mainly through further annual cost base reductions. Achievement of this objective will assist the bankin returning to sustainable profitability.

RBS’s non-core division Capital Resolution reported a narrower operating loss of £388 million relative to a loss of £612 million inQ2 2016. The division’s results benefitted from an impairment release, lower disposal losses and despite a fair value loss on own debtrelative to a fair value gain on own debt in Q2 2016. Adju sted expenses reduced by £119 million, or 65% - primarily the results of a673 reduction in headcount. RBS continued to downsize its capital markets business through its Capital Resolution unit, which is creditpositive for RBS’s bondholders due to the greater earnings volatility and tail risk inherent in these businesses.

3 4 August 2017 The Royal Bank of Scotland Group plc: 2Q17 results: Higher revenues, cost reductions and lower credit impairments return RBS to profit; capitalstrengthened

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Ratings ConsiderationsWe rate RBS's long-term debt Baa3. Long-term deposits are rated A2 and long-term senior unsecured debt is rated A3 on RBS’s mainoperating entity, The Royal Bank of Scotland plc. The ratings outlook is stable, reflecting our view that towards the end of the nexttwelve to eighteen months the bank will be more advanced in its complex restructuring exercise, have reduced non-core operations toa small residual and will begin to generate more stable and sustainable earnings.

4 4 August 2017 The Royal Bank of Scotland Group plc: 2Q17 results: Higher revenues, cost reductions and lower credit impairments return RBS to profit; capitalstrengthened

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Endnotes1 All figures in this report relate to Q2 2017 and comparisons are made to Q2 2016, unless otherwise indicated. All results are on a RBS reported basis unless

otherwise stated be on an adjusted basis. RBS adjusted basis; excludes litigation and conduct charges, restructuring charges, fair value changes in owndebt, gains/losses on redemptions of own debt, disposal gains/losses, and other items.

2 Alawwal Bank (LT deposits A3 stable, baa2 BCA). BCA: Baseline Credit Assessment.

3 RBS’s internal definition or Risk Element In Lending

5 4 August 2017 The Royal Bank of Scotland Group plc: 2Q17 results: Higher revenues, cost reductions and lower credit impairments return RBS to profit; capitalstrengthened

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6 4 August 2017 The Royal Bank of Scotland Group plc: 2Q17 results: Higher revenues, cost reductions and lower credit impairments return RBS to profit; capitalstrengthened

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Contacts

Daniel Forssen,CFA 44-20-7772-1553Associate Analystdaniel.forssen@moodys.com

Alessandro Roccati 44-20-7772-1603Senior Vice Presidentalessandro.roccati@moodys.com

CLIENT SERVICES

Americas 1-212-553-1653

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7 4 August 2017 The Royal Bank of Scotland Group plc: 2Q17 results: Higher revenues, cost reductions and lower credit impairments return RBS to profit; capitalstrengthened