Aug 14 (The following statement was released by the rating agency)
RBS's solid half-year earnings, based on an
increasingly robust balance sheet, are likely to reduce the benefit of
implementing a "bad bank" split, as currently being considered by the UK
government, Fitch Ratings says. A bad bank split is unlikely as we believe the
costs, obstacles and uncertainties involved in transferring some assets to a
state-run bad bank would exceed the benefits, in particular to the UK government
as majority shareholder in the bank and potential acquirer of assets from the
In light of this and given the large unknown elements of what could be
transferred and under what mechanisms even were some sort of split to occur, we
have not taken any related rating action on RBS.
From a bondholder's perspective, there are a number of reasons why any split is
likely to be neutral for the bank's Viability Rating, although this cannot be
assured without full knowledge of what is being considered. At its simplest, it
is difficult to imagine a restructuring being sanctioned that would increase
risk for bondholders without also reducing value for shareholders, most
obviously the UK government, one of whose very objectives is to create
shareholder value for reprivatisation.
RBS has just proved, in its recent set of results and following the UK
Prudential Regulatory Authority's recent adjusted capital requirement test, that
it can continue to operate viably under its current plans. As such, we expect
any restructuring would take place outside any existing statutory framework,
presumably involving the sale by RBS of certain assets at no less than fair
value in order to avoid a breach of EU state aid rules.
Indeed, the UK has pledged not to inject any more money into the bank. Any
restructuring scheme that fell foul of EU state aid requirements would, under
the revised rules effective 1 August 2013, require junior debt burden sharing
and, presumably therefore, dilution of the government as shareholder in favour
of junior bondholders.
For any such restructuring to go ahead, the UK government would likely need the
approval of some of the minority shareholders in RBS, who would probably want to
see a compelling valuation benefit to support a strategy that consumed
significant management time. Uplift for shareholders could be difficult to
achieve with the costs, legal complexities and valuation adjustments that
accompany a good bank/bad bank scheme.
Another consideration is that the public sector debt will likely increase by the
size of the assets selected to go into a state-owned bad bank. Public sector
banking groups, such as RBS, are excluded from the primary measure of net public
debt used by the government and the Office for Budget Responsibility. However,
like the existing state run UK Asset Resolution, the bad bank will most likely
be included on the exchequer's balance sheet, and thus be included in the public
debt. The government may have limited appetite to see an increase in the debt
level, so this would likely be a constraint for the size of a potential bad bank
The assets that could be considered for transfer into public ownership would
likely be in Ulster Bank, UK commercial real estate and some legacy portfolios.
They would also likely be loans accounted for at above fair value, so any asset
transfer at fair value would likely crystallise losses. The gap between the fair
value of RBS's loans and the carrying value at which they were held in the
accounts has fallen, but remains substantial at GBP17bn at end-H113. A large
portion of the deficit is likely to relate to Irish and property loans, even
though some will stem from low-risk assets written at uneconomic rates, such as
housing association loans.
If a split were to happen, it might be negative for reported capital ratios. But
we believe the impact would likely be moderate, considering the constraints on
the potential size of the asset pool and some capital relief from the removal of
impaired assets. There has also been media speculation that the government could
recycle any compensation it received from RBS's exit of the dividend access
share - a scheme put in place as part of RBS's bailout to make it impractical to
pay dividends to ordinary shareholders - as a further equity investment. Even if
capital ratios deteriorated moderately, asset quality would improve and tail
risks would diminish after the asset transfers.
We believe the most likely outcome is for the group to continue to follow its
planned capital actions - to deleverage further, partially float its US Citizens
operations, and reduce and reshape its markets business. One of the greatest
risks facing the RBS group is the litigation and conduct costs relating to
legacy business. This risk remains unquantifiable but potentially significant
and would be difficult to remove with a bad bank split.
A new chief executive with retail banking pedigree could lead to a strategy more
focused on the UK and further reshaping of the markets operations, which would
reduce risk-weighted assets, volatility in income and tail risk. But Ulster Bank
will remain a drag on capital, as it is not expected to become fully profitable
until the medium term.