RBS at Less Than Break-Even Valuation Discredits Osborne
Stock Chart for Royal Bank of Scotland Group PLC (RBS)
Five years after giving Royal Bank of Scotland Group Plc (RBS) a record banking bailout, the British government is making it harder to recoup its money by sowing confusion over the firm’s structure and future profitability.
Chancellor of the Exchequer George Osborne said on June 19 he’d review a breakup of the bank, the U.K.’s third-largest by assets, days after Stephen Hester’s resignation as chief executive officer. Osborne said the lender was burdened by too many poor assets, contradicting RBS Chairman Philip Hampton, who told investors five weeks earlier the government could start cutting its 81 percent stake next year.
“RBS is facing more problems now than it was six months ago -- and that must be partly attributed to government interference,” said Christopher Wheeler, an analyst at Mediobanca SpA in London, who recommends selling the stock. “The idea of the government even considering starting the sell-down process before the end of next year is overly optimistic.”
Since its 45.5 billion-pound ($69.9 billion) rescue, the bank has shrunk assets by almost half, posted five consecutive years of annual losses and still trades below the price the government says it needs to break even. Osborne will struggle to meet his 2010 election pledge to offer RBS shares to voters, a sale Hester said would symbolize Britain’s economic recovery.
Owning RBS has made the government vulnerable to criticism over banker compensation, lending to companies and the manipulation of benchmark interest rates. The opposition Labour party has attacked Osborne for allowing RBS to pay executive bonuses and failing to police the investment bank. Ed Balls, Treasury spokesman for the Labour party, this month blamed Hester’s ouster on political meddling.
It “sent a bad signal around the world about the way government is working with business,” Balls said at a July 2 conference organized by the Times newspaper. “It will be harder and take longer to be where we want to be, which is RBS off the government books and back in the private sector.”
“The crucial thing is to be seen to be doing it competently rather than to be seen to be indulging in some kind of fire sale, which then begins to fall to pieces as they rush it,” said Tim Bale, a professor of politics at Queen Mary, University of London.
RBS advanced 0.3 percent to 335.8 pence in London trading today, below the 407-pence break-even price. The stock has climbed 4.8 percent since Osborne’s speech, after falling as much as 15 percent. By contrast, Lloyds Banking Group Plc (LLOY), 39 percent owned by the government after a 20 billion-pound rescue, is trading at 68.11 pence, above the 61-pence break-even price.
RBS has lost 95 percent of its value since the end of 2006, the year before then-CEO Fred Goodwin led the 72 billion-euro ($95 billion) purchase of Amsterdam-based ABN Amro Holding NV. The takeover left the Edinburgh-based lender excessively dependent on short-term funding, bringing it close to collapse after Lehman Brothers Holdings Inc.’s bankruptcy in 2008, according to a December 2011 report by the Financial Services Authority. Goodwin, 54, was stripped of his knighthood last year and can no longer use the title “Sir” before his name.
The tone of Osborne’s Mansion House speech surprised investors, sparking the initial sell-off, Wheeler said.
While Osborne was reluctant at first to consider a breakup of RBS, the idea has since gained support within the Treasury, according to a person with knowledge of the matter.
The chancellor appointed Rothschild, BlackRock Inc. (BLK) and Slaughter & May LLP to review RBS’s structure after former Bank of England Governor Mervyn King told lawmakers in March the lender should be fully nationalized. The bank should then be split up, with the “good” pieces re-privatized, King said.
The Parliamentary Commission on Banking Standards, set up by the chancellor after Barclays Plc (BARC) was fined 290 million pounds for manipulating the London interbank offered rate, or Libor, said in its final report published last month that the government should carry out a “detailed analysis” of the proposal to divest RBS’s toxic assets into a bad bank.
Hester, who replaced Goodwin as CEO after the 2008 bailout and plans to step down in December, has shrunk the balance sheet by 900 billion pounds and cut 41,000 jobs out of 199,800. Assets that the bank plans to sell or run down declined to 53 billion pounds at the end of the first quarter from 258 billion pounds at the end of 2008, making it easier for the government to contemplate splitting off those holdings.
The bad bank will include unwanted businesses such as consumer and commercial real estate loans and Ulster Bank assets, Frederik Thomasen, an analyst at Goldman Sachs Group Inc. in London, wrote in a July 9 note. The unit probably would house “high risk” commercial-property assets that aren’t part of Ulster Bank or Citizens Financial Group Inc., RBS’s profitable U.S. consumer and commercial business, he said.
The bad bank would hold about 85 billion pounds of assets, or 6 percent of the group total, accounting for 75 percent of its provisions, said Thomasen, who recommends buying RBS stock.
“Any split would, we believe, be costly and time-consuming to implement and would surely involve the transfer of assets at below existing carry values, destroying value for all existing stakeholders,” said Ian Gordon, an analyst at Investec Plc (INVP) in London with a hold rating on the stock. “RBS is going to remain under pressure to do things that are suboptimal and value-destructive. This government-mandated rolling restructuring is not at all helpful.”
Uncertainty over the future direction of the business led Moody’s Investors Service to put RBS’s credit rating under review this month.
“Moody’s action reflects the further uncertainty for bondholders resulting from the U.K. government’s recent announcement that it is examining the merit of a possible breakup of RBS and how this could be achieved,” the ratings company said on July 5. “Some of these options may entail losses for creditors.”
The prospect of the government using RBS’s existing bondholders to finance the riskier bad bank unnerved investors, Simon Adamson, a London-based analyst at CreditSights Inc., wrote in a June 23 note to clients.
“We would expect that subordinated, and perhaps senior unsecured, debt would be part of the funding for any bad bank, and that will continue to influence bond prices until a decision is made,” Adamson wrote. “It is probably the last thing RBS needs when it is consolidating its financial recovery.”
The cost of insuring RBS’s subordinated bonds from default was 368 basis points yesterday compared with 310 basis points on June 19 and a low for the year of 232 basis points on May 22, according to data compiled by Bloomberg. A basis point is 0.01 percentage point.
Hester, a former head of fixed income at Credit Suisse Group AG, resigned four months after he bowed to pressure from the government and regulators to shrink the investment bank and sell a 25 percent stake in Citizens. The U.S. unit, which RBS bought in 1988, had a profit of about 754 million pounds last year, accounting for 12 percent of the British bank’s total profit from the core operations it plans to keep.
“We expect enduring strategic uncertainty, fears around non-bad-bank ideas in the autumn and low returns from a core bank in transition,” Jason Napier, a London-based analyst at Deutsche Bank AG, who recommends selling the stock, said in a note to clients last week.
Under government influence, the bank cut an additional 2,000 jobs at its securities unit last month in addition to the 3,800 announced last year, when it decided to sell or close its unprofitable cash equities, mergers-advisory and equity-capital-markets divisions.
Revenue from the unit, the second-largest by assets after consumer and commercial banking, fell to about 1 billion pounds in the first quarter from 1.7 billion pounds a year earlier. That still accounted for about 18 percent of the group’s total revenue during the period.
Since 2008, RBS’s market share in underwriting bond sales and syndicated loans has dwindled. The bank ranked seventh in arranging syndicated loans in Europe, the Middle East and Africa this year, according to data compiled by Bloomberg. It held the top spot in 2008. RBS is 12th in underwriting international bonds in 2013, down from sixth in 2008, the data show.
RBS also has boosted its share of the U.K. mortgage market. In 2011, the bank was the fifth-largest mortgage originator by gross lending, accounting for 10.4 percent of the market, according to data compiled by the Council of Mortgage Lenders. In 2008, it held the same spot with 7.3 percent. Its U.K. gross residential mortgage lending has increased 33 percent to 110.2 billion pounds since 2008, the bank said in May.
Osborne has said he wants RBS to be a U.K.-centered bank focused on providing mortgages and banking services to individual and corporate customers.
“We believe RBS’s future is as a major U.K. bank with the majority of its business in the U.K. and in personal, SME and corporate banking,” Osborne told the House of Commons in London on Dec. 20, referring to small- and medium-sized enterprises.
The British consumer and corporate operations accounted for 59 percent of operating profit before impairments in the first-quarter, the markets unit 16 percent and Citizens 11 percent.
Hester, 52, is the third senior executive to announce his departure from RBS this year. Chief Financial Officer Bruce Van Saun said in May he was leaving to run Citizens. In February, investment-banking chief John Hourican resigned after the bank was fined $612 million for rigging Libor. Chairman Hampton said last month he might leave after a new CEO is found.
Ross McEwan, CEO of RBS’s British retail unit and Van Saun, are the top internal candidates for Hester’s job, according to a person with knowledge of the selection process who asked not to be identified because the matter is private.
RBS executives and officials at U.K. Financial Investments Ltd., or UKFI, which manages the government’s bank stakes, declined to comment. A spokesman for Goodwin didn’t return calls, and the Treasury declined to comment beyond Osborne’s June 19 statement.
RBS still has to sell its remaining 48.5 percent holding in Direct Line Insurance Group Plc (DLG) and find buyers for the 316 U.K. branches it has to sell by 2014 to comply with European Union rules that force bailed-out lenders to shrink. RBS struggled to sell the branches after Banco Santander SA, Spain’s biggest bank, pulled its 1.7 billion-pound bid in October. RBS has said it will sell the branches in an initial public offering.
The bank also has been told by the Prudential Regulation Authority to increase capital by 3.2 billion pounds to withstand possible losses on loans, fines and other risks. It said last month it would narrow the shortfall to 400 million pounds by the end of the year, with the gap closed through retained profit in the first quarter of 2014.
UKFI said in its annual report on July 15 that RBS needs to show “sustained profitability” before it can return to private ownership. It described the bank’s first-quarter operating profit of 829 million pounds, a 29 percent decline from a year earlier, as a “setback.”
Osborne is pursuing a different strategy with Lloyds. He said last month the government is “actively considering” selling shares. CEO Antonio Horta-Osorio said in May that London-based Lloyds will return to profitability in 2013, helped by a revival in the British economy. House prices are rising and the International Monetary Fund raised its 2013 growth forecast for the U.K. this month to 0.9 percent from 0.6 percent and predicted expansion of 1.5 percent next year.
Lloyds posted an almost threefold increase in first-quarter profit to 1.48 billion pounds as bad loans declined. Britain’s biggest mortgage lender is “quite advanced in its path to normalization,” according to UKFI.
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