RBS - Is George's Heart Really In A Break-Up?

20 June 2013

Michael Symonds

This publication is intended for investors who are not Retail Clients in the United Kingdom within the meaning of the Rules of the FSA.

The UK government’s apparent volte-face over breaking up the 81%-taxpayer-owned Royal Bank of Scotland, revealed by chancellor George Osborne in his Mansion House speech on Wednesday evening, has clearly unnerved markets. CDS contracts referencing the bank were wider by around 30bps at 225bps on Thursday morning, a significant underperformance of peers. Senior and subordinated cash bonds also lagged as holders weighed the risks of potentially being hived-off with the bank’s problematic assets.

Calls for splitting RBS into good and bad banks have increased in volume recently, most notably from Sir Mervyn King, the departing Bank of England governor. However, key figures in the government had continued to support the bank’s lengthy - but to date mostly successful - deleveraging and de-risking process as it drew to an expected close next year. The likely game-changer came when the cross-party Parliamentary Commission on Banking Standards recommended investigating a break-up of RBS in a wide-ranging report into the industry published just hours before Mr Osborne’s address.

But even while the chancellor’s declaration came as somewhat of a surprise, he also may only be going through the motions, as the government also insisted that several important conditions be satisfied before any bad bank restructuring is given the green light: the plan must support the UK economy; be in the interests of taxpayers; and accelerate the bank’s return to private ownership.

These are indeed noteworthy qualifications, not least the government’s assertion that no additional taxpayer funds be used in the process. RBS evidently does not have surplus capital of its own to commit to the exercise, as highlighted by the judgment of the Prudential Regulation Authority’s capital assessment, published earlier today, that the bank raises an additional £3.2bn by the end of 2013.

Our main conclusion is relatively straightforward; we are yet to see a bad bank proposal that would satisfy the government’s objectives: a plan that conclusively separates RBS’ bad assets from the clean bank – allowing this entity to be truly unburdened to support the economy, while also avoiding a lengthy and disruptive process and, most importantly, without crystallising losses for taxpayers or requiring a further commitment of public money, be it a further capital injection or government funding guarantees.

Whatever the outcome, it is important the resulting analysis is submitted for public scrutiny to ensure the matter is laid to rest once and for all. And, with that in mind, while we do not believe a solution where creditors alone bear the burden of winding down RBS’ bad assets is feasible, there is certainly a good chance that some of the strategies examined as part of the process would entail negative outcomes for bondholders. This might not be comfortable reading for more nervous credit investors.

So, on balance, we are still not convinced the government’s heart is really in a break-up of RBS, and that their preferred path from here is an accelerated disposal of US subsidiary Citizens and more aggressive reduction in the bank’s capital markets business – both points reinforced in last night’s speech. But, at least until the autumn, political interference looks set to continue the uncertainty for bondholders.

 

Michael Symonds
Credit Analyst

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