RBS Sees ‘Substantial’ Full-Year Loss, Creates Bad Bank

Royal Bank of Scotland Group Plc expects to post a “substantial” full-year loss after transferring 38.3 billion pounds ($61 billion) of its worst loans to an internal bad bank under government pressure.

Britain’s biggest publicly owned lender expects to log as much as 4.5 billion pounds of writedowns in the fourth quarter as it starts to sell the loans, Edinburgh-based RBS said in a statement today. It will also speed up plans to sell its Citizens Financial Group Inc. unit to bolster capital.

Chancellor of the Exchequer George Osborne is trying to recoup some of the cost of RBS’s 45.5 billion-pound bailout, the biggest bank rescue in the world. He started a review in June to consider whether the bank should be broken up. While the government has been able to start reducing its stake in Lloyds Banking Group Plc, RBS has been hobbled by souring loans and past regulatory mis-steps, making a sale before an election due in 18 months “unlikely,” according to Osborne.

“We may have avoided the worst excesses of a full blown good bank/bad bank split, but you are getting a lot of the medicine in the form of accelerated loss recognition as assets are manged for speed and not value,” said Ian Gordon, an analyst at Investec Ltd. in London, who rates the bank a sell. “A lot of shareholder value is being destroyed.”

The stock closed at 340 pence in London, down 7.5 percent. That’s below the 407-pence price at which the government would break even on its 81 percent stake. By contrast, Lloyds, which received a 20 billion-pound rescue during the crisis, has increased 62 percent this year, allowing the government to sell a 3.2 billion-pound stake in September. Osborne told BBC Radio today he hopes to sell more Lloyds shares in 2014.

‘British Taxpayer’

“RBS will deal decisively with the problems of the past by separating out the good from the bad,” Osborne said in a statement. “It means less exposure for the British taxpayer.”

RBS will sell or run down 55 percent to 70 percent of the bad bank’s assets in the next two years and the rest within three. That timetable “must be aggressive for RBS to put its troubles behind it,” Sajid Javid, financial secretary to the Treasury, said in an interview with Bloomberg Television’s Francine Lacqua and Manus Cranny today.

The bad bank, which will have its own managers, is similar to that set up by Citigroup Inc. The New York-based lender set up Citi Holdings in April 2009 to sell $573 billion of its most distressed and unwanted assets. That pool has now been reduced to about $122 billion.

No Comparison?

“If you look at what other big banks have done that had similar problems, and Citi is one of the best examples, they had a very similar timeframe and its helped that bank recover,” Javid said. Still, it’s “unlikely” the government will start cutting its stake before the election, he said.

RBS’s bad bank will include 14.8 billion pounds of assets from its core unit and 23.5 billion pounds from RBS’ existing non-core operation. Ireland will account for about 9 billion pounds and U.K. commercial real estate almost 2 billion pounds. At 38.3 billion pounds, the unit is smaller than the 100 billion pounds analysts had initially estimated, according to London-based Shore Capital Group Ltd.

RBS said “no direct comparison” can be made between the bad bank and the non-core division it set up in 2009 because it will house its most toxic and volatile assets, rather than those it deemed didn’t fit with its strategy.

“In light of the new strategy to deal with our high risk assets we expect a significant increase in impairments in the fourth quarter,” Chief Executive Officer Ross McEwan, 56, said.

Citizens Sale

RBS’s net loss narrowed in the third quarter to 828 million pounds from 1.4 billion pounds in the year-earlier period. The lender set aside an additional 250 million pounds to compensate clients wrongly sold payment-protection insurance, taking its total provision to more than 2.7 billion pounds.

McEwan took over as CEO from Stephen Hester on Oct. 1. Hester, 52, a former investment banker who joined RBS after its rescue, announced his departure in June after the Treasury pushed RBS to sell Citizens, the U.S. consumer and commercial lender it acquired in 1988, and shrink the securities unit.

McEwan will now speed up plans to sell RBS’s stake in Citizens. The lender will sell an initial stake in the second half of 2014 and sell the rest by the end of 2016. The original plan, outlined in February, had been to start an initial public offering in two years.

Dividend Talks

The measures will allow RBS to reduce risk-weighted assets by 35 billion pounds by the end of 2016 and bolster its capital ratios. RBS said today it will seek to have a core Tier 1 capital ratio of at least 12 percent under the latest round of Basel rules by the end of 2016. Today, the measures stands at 9.1 percent.

McEwan will also seek to reduce costs as he tries to return the bank to profitability. He plans to reduce the firm’s costs as a percentage of revenue to the “mid 50s” from a current ratio of 65 percent. Cost fell 8 percent from the year-earlier in the third quarter, but were still “unsustainably high,” McEwan said.

He is also working at removing the biggest hurdle to the bank resuming dividend payments to its shareholders. RBS said it was in “advanced discussions” with the Treasury about removing the dividend access share, which was created in 2009 and gives the taxpayer priority over ordinary shareholders.

The lender also said it’s cooperating with regulators investigating the possible manipulation of foreign-exchange markets. The bank has suspended two traders as part of the probe, said a person familiar with the decision who asked not to be identified because the move hasn’t been made public.

“We will come down very severely on anyone who we discover is breaking the rules,” McEwan told reporters on a conference call today. He declined to comment on the suspended traders.

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