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RBS 'bad bank': a compromise five years too late?
An internal bad bank
Five years after it fell into state hands RBS has finally met calls to hive off its toxic assets into a 'bad bank' in a bid to improve its service to UK businesses and customers.
However, the 'bad bank' is an internal one, not the external bank that the chancellor George Osborne, and others, pushed for in a period of tension that led to the departure of RBS's former boss Stephen Hester this summer.
The Treasury said an external bad bank would have required more support from taxpayers whereas the internal version - to be known as the RBS Capital Resolution Group when it launches in January - would be funded by the bank and would reduce taxpayers' exposure to banks by £8 billion.
Osborne claimed this was a 'new direction' for RBS that would 'lead it to being a boost to the British economy instead of a burden'.
However, shares in RBS (RBS.L) tumbled 23p, or 6%, to 344.8p after Ross McEwan (pictured), the bank's new chief executive, warned that speeding up the disposal of toxic assets over three years would cause a £4 billion spike in loan losses in the fourth quarter and lead to a 'substantial' loss for the full year.
On the other hand it will strengthen the bank's balance sheet allowing RBS to satisfy regulators and target a core tier 1 ratio of around 11% by the end of 2016. Its current ratio is a lowly 8%.
This in turn brings forward the day it can resume dividend payments to shareholders and, crucially, the point at which the government can reprivatise the bank and start to sell its 81% stake.
RBS and Treasury officials and advisers have identified a pool of £38 billion of high risk loans - many of them in Ireland - which drag down the bank's performance by tying up a fifth of its capital. These will be transferred to the resolution group, which will aim to remove 55%-70% of them in two years.
McEwan also confirmed plans for a partial flotation of Citizens, its US business, which it would also exit compeletely by 2016.
He said the reorganisation would enable RBS to deal with criticisms from Sir Andrew Large, who has reviewed the bank's lending to smaller busineses and found it wanting.
Investors spy compromise
Fund managers said the creation of the bad bank would have been more effective at the height of the credit crunch and now it could be too little too late.
Ian McVeigh (pictured), manager of the Jupiter UK Growth fund, is among those. 'The decision by RBS to set up an internal bad bank feels like a compromise,' he said.
'Despite all the talk of splitting RBS into a good and bad bank, it was hard for us to see the basis on which it could be done. Either the price at which the assets were transferred would have been too low to be acceptable to shareholders or it would have been done at a level that Brussels would have viewed as an unallowable subsidy.'
McVeigh added: 'The internal bad bank proposal feels therefore like a way of addressing both of these conflicting stresses while appeasing a political class eager to see progress on this issue.
'The time when it might have been really worth splitting the bank in two would have been back in 2009 when there were far more legacy assets rather than today when the bank’s asset base has been hugely reduced.'
Hester the hero
Henderson global equities head Matthew Beesley agreed, while applauding the work of Hester and the decisions the previous Labour government made under intense pressure.
'Stephen Hester will be judged by history, I believe, in having made a decent fist of restructuring what was a sprawling mess of a bank. The bank was over-leveraged, with insufficient capital and far too reliant on unsustainable funding sources,' Beesley said.
'This is most definitely not the case now. Alistair Darling and Gordon Brown will also I believe, be judged as having made some good decisions about RBS and the UK banking sector in the heat of the storm back in late 2008.
'Maybe a good bank/bad bank split then, would have led to a faster recovery now for the core UK part of the bank unencumbered by bad legacy debt, but six five years later we do have a UK banking sector that is slowly regaining its poise and starting to return to private ownership.'
McVeigh underlines how difficult it is to put a valuation on the bank in the current climate. 'For us, the main issue at RBS remains the need for analysts to switch their focus from book value to earnings. Analysts have focused on book value because it is usually less volatile than earnings, especially in periods of change and high volatility,' he explains.
'It could be argued though that the bank’s assets are actually more volatile than its underlying business because of constant regulatory tinkering and government interference.'
At the same time McVeigh points out the bank's assets could be understated and highlights the attraction of a potential resumption in its dividend.
'The bank is increasingly cash generative, which in time could see a substantial portion of these earnings returned to shareholders in the form of dividends,' McVeigh said.
'The consensus estimate is that the bank could be earning as much 36p to 40p a share in 2015 of which half could be payable as a dividend. This would equate to a yield of nearly 6% at current prices.'
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