After a tiring day I thought there would be nothing better to do than read and take some notes on the FSA's report into RBS's failure. They are not comprehensive, the full 452 pages are here; FSA report into why RBS failed
7/10/08 RBS funded by Emergency Liquidity Assistance from the BoE.
13/10/08 RBS £20bn rights issue, only 0.24% taken up by private holders, government the balance.
public commentary was that £40.7bn operating loss being the problem is inccorrect. Of that £32bn was intangible writedowns, which don't have an effect on regulatory capital.
"Only" £8.1bn of capital was written down.
end of 2007 had £68bn of reg cap + £12bn of rights issued raised capital, => £8bn would have been absorbed.
1) less capital than peers, therefore first in firing line (although later charts show HBOS was in worse position but Eric Daniels had a brain fart).
2) "excessively" dependent on short term funding (I use the inverted commas because, well the FSA didn't seem that bothered at the time and its NR report shows an even worse example they didn't care about).
3) asset quality concerns
4) large losses from credit trading
5) ABN amro "wrong deal, wrong price, wrong way of paying and at the wrong time"...
6) Systemic crisis.
under Basell III RBS would have had 1.97% capital ratio rather than the required 8%.
in sep07 when NR failed, RBS was still able to raise debt. thought they were experiencing a "flight to quality", really?!
customer funding gap for the whole of the UK system rose from being zero in 2000 to ~£750bn by 2008 in pretty much a straight line.
rbs had a big reliance on short term wholesale funding, even when it was levering up to buy ABN it paid in borrowed cash of less than 1yr term.
ABN effectively doubled their trading book; that only required £2.3bn of capital for £470bn of balance sheet assets. from which they took £12.2bn of losses.
FSA make a big deal about losses on credit trading, because they believe that this causes a loss of confidence, in both the institution and the system which leads to recession, which leads to defaults. Sure tighter credit hurts the economy, but part of that is signalling. trading p&l for 2007,8,9,10 were; +1.3,-8.4,+3.1,+4.5. So over the four years they made £1.3bn.
Whereas losses from loans are £32.4bn.
credit losses were £14bn over 07/08. FSA make valid point that there was a lot of uncertainty around it though, which inevitably leads to funding issues.
credit trading pnl for 2008;
they lost 2.3bn on counterparty defaults; 0.7 Lehmans, 0.6 Madoff, 0.6 Icelandic banks
-0.6 CDPC
-0.6 principal finance
-2.4 structured credit
-7.8 "strategic assets unit" ?? is that a prop desk name?
-3.2 impairments
+2.1 commission
+4.0 interest
-4.4 staff costs - is that payouts from tinning people??
organic growth of the balance sheet was 24% p.a from 2004 onwards!
losses on loans over 08-10
Residential mortgages; £2.5
personal lending 4.6
corp property 10.4
corp other 9.7
other 3.2
IMHO their enormous quickly grown loan book is the issue, and the market knew that at the time and yanked their funding. They were too reliant on short term wholesale funding so they got stopped out.
ABN deal;
paid in cash, which they borrowed rather than funding with equity.
effectively doubled their trading book.
took the risk of being consortium lead, meant they had to consolidate the purchase and then split it up, and I think is the reason they got so much of conduit losses of abn assigned to them, because that was still being discussed in early 08.
thought that because they had integrated a same country retail deal that was bigger and had good reputation on cost control and synergies they would make a lot of money on the deal. described as a "vanity purchase", "didn't know what they were buying".
because deal was competitive and of a public company, due diligence was minimal, although that wouldn't have made much difference IMHO, they had similar risks on already.
rbs board unanimous and shareholders over 90% voted in favour of the deal.
no regulatory oversight of the deal on the UK end of it - Dutch were surprised by that.
there is a lot of discussion of management styles and processes, a lot of it is waffle looking for scape goats, and a lot more of it is hindsight trading. however there are some interesting issues;
RBS were slow to take their marks. Goldmans were really quick and good at this.
RBS used the 96% for their VaR, everyone else used 99.9%, how and why were they allowed to do this. Everyone else is planning for a 1 in 1000 even, whereas RBS are planning for a 1 in 24??
losses were 8x what their VaR models were predicting. The fact they are surprised by this was worrying. Little real stress testing.
Nice breakdown. What do you think of RBS' prospects now? Will they survive the breakup of the Euro? Will they ever pay dividends? Should I buy their preferred shares now? Thx.
ReplyDeleteIt is a question of how much damage that does to the shareholder's investment and whether that is in the price?
ReplyDeleteI don't have a view as whether their assets will perform any better or worse, they do have plenty of exposure to Ireland though. Their advantage is that their depositor base must be a little bit stickier than comps because of the government stake.
I think there are easier trades to do and even if you decided you did think there was decent value in RBS there probably will be better entry points + you have a lot of government overhang and risk associated with that.
Thank you for your response. I'm an American investor researching the NatWest preferred shares currently at an 11.2% dividend yield. I've read that the issue is "ring-fenced" against the original issuing entity it must still be paid so long as that unit is profitable, even if the parent is not.
ReplyDeleteIs that true?
NatWest has 17X leverage ratio and an above Basel Core Tier 1 cap percentage; however, I read that recent BoE report, "UK banks do have significant total exposures to the private sectors in Ireland, Italy and Spain, of around £160 billion, or 80% of core Tier 1 capital. UK banks are also indirectly exposed through their lending to core euro-area banking systems." I don't know if NatWest's core Tier 1 is at risk or if that hinders their ability to pay the prefs' dividends. I see them as a profitable deposit franchise regardless and your comment about the base is stickier b/c of the UK govt ownership, makes it seem more likely they'll be around in 5-10 years paying dividends. Hard for me value or ascertain the risk. Anything else to look at the value NatWest? Best, kwg
do you have a prospectus of the issue? because the capital structure is going to be absolutely key!
ReplyDeleteYes, I have a prospectus. Prospectus: "Dividends on Series C Preference Shares are payable out of distributable profits of the Bank in US dollars" the rest is standard language and US tax consequences. NatWest has paid quarterly divvys since the crisis of 2008/2009. They strike as in a similar position as BofA in the US. What's the strength of NatWest's underlying deposit franchise is my main concern. RBS has stepped in to capitalize NatWest. Will NatWest be profitable as it unwinds from its past problems and will it make a profit, i.e. pay preferred divvys, with the Euro crisis?
ReplyDeleteshoot me an email (it is in the profile), bit easier to communicate.
ReplyDeleteI had a quick look at the prospectus of the dollar prefs guessing that the series C was what you were looking at. What I would really like to look through is a risk report and balance sheet for the NatWest sub.
NatWest franchise seems pretty decent, my family still have their current accounts with them, not that that is a huge credit endorsement, but I don't think they have lost depositors because of the crisis.
The BoE numbers and RBS's exposures to peripherals mainly are in Ireland. I would imagine though that they come from their subsid Ulster Bank, rather than a huge bet at the group level.
I'll have a look at the EBA exposures report, the country and bucketed breakdown is more useful than the conclusion.
I think this might be an ok trade actually.
I sent you an email with NatWest attachments. I noticed that the cost/income ratios for RBS & NatWest are higher than other UK banks and rising.
ReplyDeleteThru June 2011, RBS’s cost:income ratio was 63.6% compared with 51.9% in the first half of 2010. Excluding the gain on redemption of own debt and the additional PPI provision, the cost:income ratio was 58.0% compared with 53.8% in the first half of 2010.
NatWest's income ratio was 78.9% compared with 66.4% in the first half of 2010. Excluding the
gain on redemption of own debt and the provision in respect of PPI, the cost:income ratio was
unchanged at 69.1%.
Do rising costs = no preferred divvy?
Sorry for the late response, I hope my reply didn't get stuck in a spam filter or something.
ReplyDelete