Royal Bank of Scotland Plc. Market Cap. (as of 28/02/14): £53.79bn
For the 2013 fiscal year, Royal Bank of Scotland (NYSE: RBS, LON:RBS) posted a whopping £9 bn loss, the largest since its bailout in 2008. The consensus of the market was a considerably lower £5.28 bn loss, showing that the situation is much direr than previously thought. This year’s loss brings RBS to a cumulative loss of £46 bn over the past six years, since the 2008 bailout by the British government, despite several attempts at restructuring, downsizing, and shrinking the investment-banking arm of the group.
RBS’ operating loss stems primarily from aggressive downsizing of the bank’s balance sheet to improve the bank’s capital reserves. Since December 31, 2012, the Edinburgh-based bank reduced its funded assets by £130 bn to £740 bn, primarily through disposals of non-core assets and downsizing of the markets divisions. Interest earning assets were decreased by about £50 bn in the same timeframe. Despite the aggressive downsizing of the balance sheet, RBS is only slightly above the 8% threshold for Common Equity Tier 1 Ratio (CET1) regulatory capital, which stands at 8.6% as of December 31, 2013. Nevertheless, RBS aims to raise its CET1 ratio to above 12 percent in the long term.
Since the bailout, RBS has attempted to refocus itself on retail and corporate banking, by divesting its investment banking and insurance business units. In particular, RBS will collapse seven operating divisions into three customer businesses: Personal & Business Banking, Commercial & Private Banking, and Corporate & Institutional Banking. This measure is projected to a cost-income ratio of around 55%, falling in the long term to around 50%. Moreover, since Scotland, and therefore the United Kingdom, is RBS’s home market and also the strongest one, the Bank is trying to strengthen its European and US presence while retaining its presence in Asia.
The Turnaround Plan was formulated in June 2013, in response to a recommendation by the Parliamentary Commission on Banking Standards. The UK Government announced it would review the case for an external “bad bank”, based on three objectives: accelerating the return of RBS to the private sector, supporting the British economy, and realizing the best value for the taxpayer.
Following this announcement, RBS worked closely with Her Majesty’s Treasury (HMT) and its advisers to identify a pool of assets with particularly high long-term capital intensity, credit risk, low returns and/or potential stress loss in varying scenarios. The review concluded that the effort, risks, and expenses involved in the creation of an external bad bank could not be justified. It also concluded that RBS’s existing provisions suggested that projected future losses are appropriately covered.
As a result, in order to deliver its capital plan RBS has formed the Capital Resolution Group (CRG), which is responsible for disposing the assets in RBS Capital Resolution, delivering the IPO for Citizens Bank, and the divestiture of Direct Line Insurance, while optimising the bank’s group-wide shipping business.
The RBS Capital Resolution (RCR) was set up from 1 January 2014 and will manage a pool of £29 bn of assets with particularly high capital intensity or potentially volatile outcomes in stressed environments, aiming to accelerate run-down of these exposures to free up capital for the bank. The revised strategy to run down high-risk loans faster led to an increased impairment charge. When originally announced, RCR assets were projected to be £38 bn at the end of 2013 (which together with derivatives were forecast to attract about £116 bn of RWA equivalents), but accelerated disposals and increased impairments have reduced this total to £29 bn.
On Feb 26, 2014, RBS divested of its stake in Direct Line Insurance PLC (LON:DLG), valued at around £1.14 bn, representing about 28% of DLG’s market capitalization, in an attempt to raise its regulatory capital requirement. Further in its plans to divest of its subsidiaries, RBS announced in a press release issued on November 1, 2013 that it would accelerate its spin-off of the American subsidiary, Citizens Bank, through an initial public offering scheduled for the second half of 2014, with secondary offerings to follow in order to divest of the American bank completely through 2016.
Despite suffering such a huge loss in 2013, RBS has defended plans to pay £588m in staff bonuses. Even though the size of this year’s bonus pool fell 18% from the previous year, the Bank’s CEO, Ross McEwan, acknowledged that the issue was highly emotional. Mr. McEwan has publicly stated that he needs to pay his staff fairly in accordance to the job market. Although the public opinion seems to oppose the decision of the government, which is to forgo imposing restrictions on staff bonuses, it is still true that in a sector characterized by a fierce competition among market players, it is necessary to maintain compensation above a certain level to retain the human capital of the firm.
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