Impending oblivion for RBS investment bank

IFR 2008 2 November to 8 November 2013
7 min read

Keith Mullin Commentary image

Keith Mullin
IFR Editor at Large

ROSS McEWAN’S FIRST message as chief executive of RBS on November 1 ticked a lot of the boxes on the UK government’s wish-list. Given the intensely political nature of his job, that was hardly surprising. At the end of the day, he hasn’t got much room for manoeuvre with the government breathing down his neck.

Throughout his entire message, he only made one passing reference to the investment bank. “The restructuring of our investment bank to lower its risk profile is in full swing and it is encouraging to see some signs of delivery from the business focus on our corporate and institutional customers,” he said. That sounded fairly neutral, but it’s clear from the Treasury’s bad bank review that the division is heading to the gallows.

Even after everything that has happened to blast the investment bank to kingdom come, the business is still strong in the markets in which it has remained. RBS is still one of the world’s leading debt underwriters, securitisers and global syndicated lenders with league-table positions across most broad data cuts just a whisker outside coveted top 10 positions. I say that’s not bad at all.

During a quarter in which its larger peers have struggled, RBS put in a pretty good performance during the third quarter. The £146m of primary credit market revenue was 7% higher than the previous quarter and up 29% on the same quarter of 2012. In fixed income and currency trading, where so many have fallen, revenues were 10% up on the second quarter and 22% down on last year – better than Goldman Sachs, Deutsche Bank, Barclays or the like. On an industry comp basis, that’s pretty sound.

Under the review, £38bn of bad assets from the investment bank, which attract £115.6bn of RWAs with associated derivatives, will be shoved into the RBS Capital Resolution Group. That was an obvious outcome.

The review ultimately did little but to needlessly line the pockets of Rothschild and Blackrock at taxpayers’ expense – the same taxpayers who incidentally funded the review into SME lending led by former Bank of England deputy governor Andrew Large and carried out by Oliver Wyman, which in essence attributed much of the decline in RBS’s small business lending to the bank’s bailout and its subsequent and dramatic rehabilitation efforts. Genius!

At the end of the day, it’s all about capital: the capital-consuming assets going into the bad bank take up about 20% of group capital. Factoring in the lower recovery value associated with the accelerated run-off plan – the bank expects to take an extra impairment charge of between £4bn and £4.5bn in the fourth quarter – will only cut the CT1 capital ratio by 10bp, McEwan noted, and this will be offset by a further £35bn RWA reduction by the end of 2016 with a counterbalancing net incremental improvement to the CT1 ratio.

It’s clear from the Treasury’s bad bank review that the investment bank is heading to the gallows

BUT GIVEN THE refocus on domestic SME lending and retail/consumer finance, it is pretty clear that changes to the investment bank go much further than shifting a few assets into the internal bad bank. I can’t see any other way the investment bank can be salvaged. McEwan, like his counterpart at Barclays Antony Jenkins, is a retail man and his comfort level outside this sphere isn’t high. I doubt he’s fighting the politically-inspired business redirection that hard.

We’ll have to wait until February for McEwan to unveil his investment-bank death-knell strategy so he can serve customers “from a more efficient, effective and agile business platform than the one we have today”, but the direction of travel is clear. The review will reveal how the bank plans to get the cost-income ratio down from 65% to the mid-50s. That’s going to result in some pretty swingeing cuts and will see the investment bank sharply concertina-ed, particularly as its cost-income ratio is a toppy 75%.

The language in the Treasury’s bad bank review is barely concealed and should have all RBS’s markets staff dusting off their resumes with immediate effect. “The markets division has generated disappointing returns for several years now and will face considerable challenges, and may need to undergo further restructuring, if it is to compete effectively in future,” the Treasury darkly stated.

Other sound-bites are equally depressing: “RBS will … continue to shrink its investment banking arm, looking to leverage strong UK large corporate relationships further, with a review of its markets division to be published in February 2014. Following these actions, RBS will be re-focused on its core role as a British retail and commercial lender.”

And: “The markets division has exited, and will continue to exit, products where it has little competitive advantage or is not a top tier, credible player. For example, its equities businesses have been sold or closed and it will continue to exit peripheral market-making activities, retail structured products and equity derivatives.”

Game over, I’d say.

ON A BROADER level, even though RBS posted its seventh consecutive quarterly operating profit, the CEO pointed out that the numbers were driven more by a fall in impairments rather than an increase in income, while core RoE of 7.7% in Q3 2013 was lower than the 8.9% and 9.3% reported for the past two calendar years. McEwan noted that the current pace of momentum in the group’s core businesses meant it is not rebuilding capital quickly enough.

He’s targeting a 300bp uplift to the current fully loaded Basel III CT1 ratio by end-2016, pushing it up to around 11% by the end of 2015 to 12%-plus by the following year. To help him get there, the 20%–25% partial IPO of Citizens will be prioritised and pipelined for 2014, with secondary sell-downs giving RBS a full exit by 2016. Morgan Stanley is in pole position to bookrun the deal.