RBS Faces Nuclear Winter as CEO Dismantles Goodwin’s Bank

The Royal Bank of Scotland Group Plc (RBS) logo is seen on the company's headquarters in London on Dec. 12, 2011. Photographer: Jason Alden/Bloomberg

By Thursday lunchtime in London, the 18,900 employees in Royal Bank of Scotland Group Plc’s investment banking division will know whether they still have jobs at Britain’s biggest government-owned lender.

Chief Executive Officer Stephen Hester, 51, decided to make the announcement, originally planned for later this month, because uncertainty in the ranks about jobs was undermining productivity, said one senior executive who declined to be identified because he wasn’t authorized to speak publicly.

Hester is reversing a decade of expansion led by former CEO Fred Goodwin that included $140 billion of acquisitions. The Edinburgh-based lender plans to close its equities and corporate finance units globally, cutting as many as 5,000 jobs, said two people familiar with the situation. The cash equities, equity research, corporate broking as well as mergers and acquisitions units may also be shut, the people said. Limiting cuts to the equities unit may not be enough to boost profitability, said Raul Sinha, an analyst at JPMorgan Cazenove in London.

“Addressing only the equities business profitability is insufficient to change the global banking and markets unit’s return on equity prospects, given that the issues are capital consumption as well as costs,” said Sinha in a note to investors.

Banking Review

Hester is extending cuts he made when he reviewed the bank’s operations in 2009 after he took over from Goodwin, 53. Since that time he has cut the bank’s assets by about 1 trillion pounds ($1.54 trillion). He retreated from some markets in Asia, running off loans and selling units including the European division of commodities-trading business RBS Sempra, which JPMorgan Chase & Co. bought for $1.7 billion. At the same time he expanded the bank’s equities and advisory business on the continent.

The European debt crisis has forced securities firms to scale back or close divisions that trade equities in Europe. UniCredit SpA, Italy’s largest bank shut its European equities unit in November, joining a growing list of companies including Nomura Holdings Inc., that have eliminated jobs in the region.

When McKinsey & Co. reviewed RBS in 2009, the management consulting firm came up with possible scenarios of what the future might look like for the board to consider. The worst-case, involving a deterioration in the global economy and RBS losing market share, was headed “Nuclear Winter,” according to a former RBS executive who helped to devise the strategy. The executive, who declined to be identified because the talks were private, said that the sovereign debt crisis and new regulation, including the planned insulation of consumer banking as outlined by the Independent Commission on Banking in September, had made the reality much worse.

Fleshed Out

The overhaul, which will be outlined in brief this week and fleshed out when the bank reports year-end earnings on Feb. 23, will call for the transformation of RBS into a U.K. and U.S.- focused consumer bank and lender to companies. The firm will retain its payment-processing arm under the plan along with a smaller investment bank focused on underwriting and trading debt, the people with knowledge of the matter said.

RBS spokesman Michael Strachan and Andrew Whitehouse, a spokesman for McKinsey & Co. in London, declined to comment.

The pending move marks a return to how the bank looked in 2004 “before the GBM runaway growth phase,” according to Bruce Packard, analyst at Seymour Piece Ltd. in London.

Acquisition Spree

RBS increased its balance sheet more than sixfold to 2.4 trillion pounds in the seven years to the financial crisis of 2008, as Goodwin sought to push the lender beyond its Scottish origins. The lender was Europe’s biggest arranger of leveraged loans from 2004 to 2008. Goodwin’s acquisition spree culminated in the 72 billion-euro ($92 billion) takeover of ABN Amro Holding NV with partners Banco Santander SA and Fortis. RBS acquired the Dutch bank’s Asian and securities units.

RBS’s investment bank accounted for 26 percent of RBS’s 7.85 billion-pound pretax profit in 2004, according to data compiled by Bloomberg. As Goodwin expanded, so too did his reliance on the unit: By 2007, the securities division generated 47 percent of the lender’s 9.19 billion-pound pretax profit. It contributed about a third of profit in the first nine months of last year.

RBS last month was ordered by the government to shrink its investment bank as part of a strategy to scale back what it termed “riskier activities.” The bank is 83 percent taxpayer-owned. Profit in the division fell 42 percent in the first nine months of 2011. The lender’s shares slumped 50 percent in London trading last year compared to a 32 percent drop for the 46-member Bloomberg Europe Banks and Financial Services Index.

‘Substantial Drag’

The shares gained 5.3 percent to 21.13 pence at the close in London for a market value of 23.3 billion pounds. That compares with the government’s break-even price of about 50.2 pence on its 65.5 billion-pound investment in the bank.

“The current difficult revenue environment does not allow RBS to generate anything like a decent return in its investment bank,” James Invine and Philip Richards at Societe Generale SA said in a note. “Global Banking and Markets is a very substantial drag as it stands today.”

RBS’s investment bank, run by John Hourican since the departure of Johnny Cameron in 2009, faces higher fixed costs after new rules on bonuses led banks to pay their employees higher base salaries as a proportion of total compensation.

The inflated wage bill came just as markets declined, making it harder for companies to sell shares and make acquisitions. Global share sales and rights offerings fell about 30 percent to $559.7 billion in 2011 from $803.7 billion in the year-earlier period, according to data compiled by Bloomberg. The value of M&A rose 4 percent to $2.28 trillion in 2011 from a year ago although it’s still almost half of the $4.04 trillion of announced transactions in 2007, the data show.

“I don’t think they’re being radical enough,” said Seymour Pierce’s Packard. “The revenue is not worth anything if you can’t control the staff costs.”

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