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Announcement:

Moody's changes RBS financial strength outlook to stable from negative

15 Jul 2010

C- Bank Financial Strength rating outlook to stable from negative; Aa3 debt/deposit ratings affirmed

London, 15 July 2010 -- Moody's has changed the outlook on Royal Bank of Scotland plc's C- standalone Bank Financial Strength Rating to stable from negative and affirmed the Aa3 senior debt and deposit ratings, which already had a stable outlook. The P-1 short-term rating was also affirmed. The C- Bank Financial Strength Rating maps to a standalone rating of Baa2 on the long-term rating scale. The change in outlook is based on the gradual stabilisation that is taking place in the financial profile of RBS as a result of management actions to restructure the bank, and a reduced likelihood of the standalone rating moving lower over the short- to medium term.

The outlook on the C- Bank Financial Strength Rating of National Westminster Bank plc and the outlooks on the subordinated debt and hybrid ratings of the group (including RBS NV) were also changed from negative to stable in line with the outlook change for RBS. The A1/P-1 ratings of the holding company, Royal Bank of Scotland Group, were affirmed.

RATIONALE FOR CHANGE OF OUTLOOK

Since the last rating action in November 2009 when the Bank Financial Strength Rating was affirmed at C- with a negative outlook following the finalisation of RBS' accession to the UK government's Asset Protection Scheme, some notable improvements have become visible:

• an ongoing reduction in leverage and strengthening of liquidity, including (i) an increase in the liquidity pool from GBP121bn at the end of H109 to GBP165bn at the end of Q110, ii) a reduction in short-term borrowings from GBP172bn to GBP139bn, and iii) and an improvement of the loan-to-deposit ratio from 144% to 131% over the same time period;

• a reduction in single-name concentrations;

• early indications that the recent high level of asset impairments may have peaked (GBP2.7bn in Q110, compared to GBP3.3bn in Q309);

• an increase in the Net Interest Margin from 1.75% in Q309 to 1.92% in Q110 against an environment of margin compression among many smaller banks and building societies in the UK.

Moody's still considers that the profitability of UK banks will come under pressure from elevated impairments over 2010 - 2011, despite early indications that they may be past the peak. The pressure may come particularly from areas such as consumer finance -- which is vulnerable to an increase in unemployment, or from commercial real estate -- where lower quality properties face refinancing challenges over the next 1 -- 2 years.

However, the rating agency considers that further loan impairments and structured credit write-downs at RBS can be absorbed at the bank's C- Bank Financial Strength Rating level. Moreover, taking into account the Asset Protection Scheme covering GBP282bn assets and the GBP8bn government contingent capital that was made available last November, Moody's views RBS as able to withstand Moody's severe stress test without a need for further capital support.

Nevertheless, the C- Bank Financial Strength Rating also incorporates the many challenges facing the bank, which is still in the early stages of a multi-year restructuring process:

• the wind-down of the large portfolio of Non-Core assets (GBP194bn at Q110) and, along with that, a reduction in the bank's high utilisation of wholesale funding;

• the sale of businesses due to European Commission requirements in return for approval of the state aid;

• the reduction of a large sectoral exposure to commercial real estate, and the embedding of a stronger risk management framework.

Alongside these challenges is the risk of a further downturn in the UK economy and the management of the inherent risks of the bank's investment banking activities.

"With the measures that RBS has been taking to restructure the bank, its standalone credit strength is well captured at the current standalone rating level with limited downside risks", said Elisabeth Rudman, a Senior Credit Officer at Moody's and lead analyst for RBS. "At the same time, we do not expect upward rating pressure on the rating until the bank has been able to progress significantly in its restructuring process, notably to further reduce Non-Core assets and deliver a consistently lower level of impairment charges. Any upward pressure would also require a visible and sustained track record illustrating that the risks within the investment bank are well controlled", Rudman continued.

A key focus for our ratings of complex wholesale investment banks, which to some extent also applies to RBS, is to what extent the firm's risk appetite and the management of the capital market activities exposes investors to higher volatility. Entering into the crisis, RBS had gaps in its risk management framework. Although new management has made much progress in strengthening risk management, we believe it will take some time for new processes and a new culture to be embedded throughout the entire organisation.

RATIONALE FOR AFFIRMED Aa3 SENIOR DEBT RATING, STABLE OUTLOOK

The Aa3 senior debt rating with a stable outlook continues to incorporate an expectation of high support by the UK government. (Please also refer to the Special Comment "Phasing Out Extraordinary Support Assumptions from UK Bank Ratings" published in March 2009, for further information on our views on systemic support for UK banks). Although we expect with time to phase out the levels of extraordinary support incorporated in the ratings of banks such as RBS (which has 5 notches of uplift from the Bank Financial Strength Rating to the senior debt ratings), an important factor in our assessment will be the outcome of further government actions, including the government-sponsored commission to review splitting investment banking activities from retail and commercial banking, the development of living wills, and the timing of the sale of the government's shareholding in RBS.

PREVIOUS RATING ACTION & METHODOLOGY

The last rating action on the bank's Bank Financial Strength Rating was on 3 November 2009 when the Bank Financial Strength Rating was affirmed at C- with a negative outlook. The last rating action on the bank's hybrid ratings was on 22 April 2010 when the review on 30 hybrid and junior subordinated instruments was concluded. The principal methodologies used in rating this issuer were "Bank Financial Strength Ratings: Global Methodology" (February 2007) and "Incorporation of Joint-Default Analysis into Moody's Bank Ratings: A Refined Methodology" (March 2007), which can be found at www.moodys.com in the Rating Methodologies sub-directory under the Research & Ratings tab. Other methodologies and factors that may have been considered in the process of rating this issuer can also be found in the Rating Methodologies sub-directory on Moody's website.

RBS Group is based in the United Kingdom, and had total assets of GBP 1,696 billion at 31 March 2010.

London
Elisabeth Rudman
VP - Senior Credit Officer
Financial Institutions Group
Moody's Investors Service Ltd.
JOURNALISTS: 44 20 7772 5456
SUBSCRIBERS: 44 20 7772 5454

London
Johannes Wassenberg
MD - Banking
Financial Institutions Group
Moody's Investors Service Ltd.
JOURNALISTS: 44 20 7772 5456
SUBSCRIBERS: 44 20 7772 5454

Moody's changes RBS financial strength outlook to stable from negative
No Related Data.
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