LONDON, Dec 21 (IFR) - Alistair Darling had little idea of
exactly what he was buying when he signed off on a 20 billion
pound state rescue of the Royal Bank of Scotland just after 6am
on October 13 2008.
The collapse of Lehman Brothers four weeks before - the
biggest bankruptcy in history - had sent markets into a
tailspin, halting interbank lending. Days earlier, RBS chairman
Tom McKillop had called Darling to warn that the bank was hours
from collapse, precipitating the decision to take the world's
largest bank into public ownership.
Events had progressed so quickly that neither Darling nor
anyone within the UK government had had a chance to look at the
bank's books. RBS was sitting on 2.2 trillion pounds of assets,
then equal to the annual GDP of the UK and Spain combined, but
nobody knew how bad those books were.
The bank's chief executive Fred Goodwin, then a knight of
the realm, had grown so suspicious of RBS's own accounts that he
had asked one of his lieutenants to fly in for a second opinion
just a few weeks before.
"What we were bothered about was the general condition of
British banks, many of which had the look of death about them,"
said Darling, then Chancellor of the Exchequer. "They just
didn't have enough capital. We were drawing up plans, but we
couldn't share details with banks. We couldn't do due diligence
because of the lack of time."
It was months before the dire state of RBS's finances would
become clear. The bank was in a far worse position than had been
imagined; it was stuffed with worthless junk. Darling later
learned the bank owned a golf course in Florida that was 70
miles from the nearest road and a cemetery in the US Deep South.
What began was a long process that is still ongoing to clean up
the books, return to profit and pave the way for the government
selling its stake.
Goodwin had agreed to go as a price for the rescue. But
McKillop and Johnny Cameron, who was head of the global banking
and markets division, insisted on holding on to their jobs for a
few more months.
Eventually, the two backed down. Stephen Hester, an
investment banker by trade and former boss of British Land, took
the CEO role, while Philip Hampton became chairman. John
Hourican, the man asked by Goodwin to re-examine the books, took
the helm at GBM.
The bank was still haemorrhaging money, not least in GBM.
Emergency liquidity from central banks had helped stabilise
things, but many of RBS's assets were plunging in value by the
"The turnaround strategy was to salvage whatever it could
from the ruins - to save whatever could be saved initially,"
said Darling, who said he never considered closing down GBM. "It
was all about crisis management. It was never a case of
splitting out the retail bank and running down the investment
"We all had an on-the-beaches attitude at the time," said
Hourican, who until Goodwin called him back had been working in
Amsterdam unpicking RBS's joint acquisition of ABN AMRO in what
then was the biggest bank takeover in history.
"The problems we were discovering were large and continuous.
Every day, we would see the value of the assets we were sitting
on move significantly - and usually down. A lot of the stuff on
the balance sheet was becoming rapidly illiquid and very
difficult to value."
What started were many months of shrinking the books, a task
which soon fell on Peter Nielsen, the former head of rates who
was quickly placed in charge of the markets business, which
generated the lion's share of GBM revenues.
"In those early days, every single day was spent trying to
get the books down, making sure the books were smaller at the
close of business than they had been at the beginning of the
day," he said. "It was a very difficult period. A lot of the
systems we relied on had helped bring down the bank. It was like
flying in the dark with no instruments."
Under the stewardship of Cameron, GBM had grown to dominate
the bank. In the last two full years before the bailout it had
contributed about a third of RBS's total revenues. It also
commanded about half of the balance sheet, mostly funded by
short-term debt. Hourican was tasked with shrinking the business
massively, and brought in McKinsey to help him figure out what
"We needed to determine what we should be, what risk
appetite we should have, and spent two to three hours every day
taking apart and analysing the strategy, thinking about whether
the same markets would even exist a few months down the line,"
said Hourican, who took the difficult decision of closing down
the leveraged finance team he had formerly run because he saw
little future for the asset class - at least at RBS. "When in
doubt, we would close down the business," he said.
By February, when RBS unveiled a 24 billion pound loss for
2008 - the biggest in UK corporate history - the new strategy
was ready. GBM saw the biggest overhaul, with many of its
pre-crisis businesses such as proprietary trading, real estate
lending, asset management and project finance shut down.
The business would cut its risk-weighted assets by 45
percent to 150 billion pounds and concentrate on what it was
good at. The idea was that the slimmed-back unit would generate
"steady and significant profits", Hester told investors.
A major piece in the strategy was the decision to park
assets with a face value of 385 billion pounds - about one in
six of all the assets the bank owned - into a non-core division,
to be run off or sold over time.
The assets came from businesses in which the bank no longer
saw a future, and many of them were worth significantly less
than what they had been bought for. Of the 385 billion, some 350
billion came from GBM alone, indicative of the mess Cameron had
made. The idea was that Hourican and others could concentrate on
turning around what they had left, without distractions.
The non-core unit was born of compromise. Some at the firm
had been pushing for a so-called bad bank, which would have
definitively split off the ropey assets in a separately-run,
separately-capitalised entity. They were concerned that by
keeping the old assets on RBS's balance sheet, the ongoing
operations would continue to be tainted.
They had a point - over the next three full years, the
non-core assets would generate almost 25 billion in losses for
the group. But Darling vetoed the plan. "We did look at the
possibility of creating a bad bank completely separate from RBS,
but we concluded that the costs would just be too large for the
taxpayer, who would be left with any losses," said Darling.
What the government did agree to, however, was an insurance
package for RBS that would essentially put a cap on its losses
and boost its capital ratios to meet minimum standards. RBS's
participation in the Asset Protection Scheme was agreed in
February 2009, initially slated to provide protection for 325
billion pounds of assets - both core and non-core. Darling was
happy: the assets would remain with RBS, and there was a good
chance the scheme would not have to pay out if the economy
But it was a big gamble. And details needed to be hammered
out, a process that took much of the year. RBS was not happy
about the 6.5 billion pound fee the government wanted to charge,
or the Treasury's insistence that it gives up some tax relief.
Lloyds initially signed up too, but backed out of the deal
in November, putting pressure on the government to ensure the
APS was not a flop. A deal was struck: RBS agreed to insure 282
billion of assets, take the first 60 billion in losses and pay
700 million a year in fees. As a condition for the aid, the
European Commission ordered RBS to sell its stake in commodities
"The scheme was very much unchartered territory," said Bill
Dickinson, who joined the Asset Protection Agency in early 2010
and later became its chief executive. "But it was immediately
successful, in that the market saw that the government was
willing to support banks and stand behind their assets to ensure
financial stability." RBS exited the scheme this October, by
which time the APS had taken 2.5 billion pounds in fees - while
never paying out a penny to the bank in claims.
Part of the reason the APS was watered down slightly was
because the wider economy was showing signs of improvement - the
"green shoots". With cheap funding readily available from
central banks and trillions of dollars of fiscal stimulus
packages from the US, China and elsewhere, GBM revenues soared.
It immediately went back into the black. Indeed, business was so
buoyant throughout 2009 that it became GBM's most profitable
year ever - it made 5.7 billion pounds.
It was quite a turnround for the business that months
earlier brought the bank close to collapse. During that first
full year after the bailout, GBM made more than five times the
profits of any other part of the bank. Since the end of 2008, it
has contributed more than 13 billion pounds in profits to the
group - twice that of RBS's corporate franchise, in second
place. According to Hourican, the rebound was important for
morale - although the feeling about GBM's success within the
group was somewhat mixed.
"The first quarter of 2009 helped show we were still alive,
and people around could see that clearly," he said. "All of a
sudden, the world could see that we had a business that could
still survive. But it was quite clear that many of the guys in
the rest of the group still blamed the investment bank for
everything that had happened, and we had to respect that opinion
- the management of the investment bank, after all, had
contributed to destroying their wealth and their brand."
Markets agreed: from a low of 10 pence in January, RBS
shares surged as high as 58 pence by August. Significantly for
Darling, that was above the threshold at which the UK government
would break even.
The success of GBM was only a half truth, however. While the
businesses it had chosen to keep were doing very well, the
investment bank benefited massively from being able to chuck
most of its junk into non-core, which made a loss of 14.6
billion in 2009. Most of that was old GBM junk. Still, things
were on the up. Amid the surge in market confidence, the bank
even managed to sell off more than 2 billion of its holdings,
including a 4.3 percent stake in Bank of China and 50 percent of
Spanish insurer Linea Directa.
The good times were not to last, however. Greece saw to
that. Concerns had been growing through the back end of 2009
that Athens might not be able to pay back bonds maturing the
following year, but it was the downgrade of those bonds to junk
the following April that sent markets reeling. Eurozone
governments helped bail out the sovereign to the tune of 110
billion euros that May, but the damage had already been done.
Investors were nervous. The European sovereign crisis had
Attention quickly turned to Ireland, which in June 2010 had
posted its 10th consecutive quarter of year-on-year economic
contraction. Mortgage, personal loan and business defaults were
on the up, and RBS was massively exposed - it had 44 billion
pounds of outstanding loans in Ireland and Northern Ireland
through its Ulster Bank unit. Worse still, GBM profits, which
had cushioned the impact of impairments through the previous 18
months, were falling off. They dropped almost 40 percent in 2010
to 3.5 billion pounds.
According to Darling, the UK government at one stage
considered forcing the Irish government to take RBS's
problematic Ulster assets into the country's bad bank, the
National Asset Management Agency.
"Legally, we could have insisted that the Irish assets of
RBS and HBOS be included in the Irish bad bank, but we were
quite conscious that if we insisted on Dublin taking on the
additional debt then we may have torpedoed that scheme
entirely," he said. "We decided to be good neighbours and let
At this time, the Bank of England was also becoming
concerned about general bank funding. RBS and others had been
big users of its emergency liquidity facilities, not least the
so-called special liquidity scheme, which was open between April
2008 and January 2009 and allowed banks to swap assets for UK
government debt for a period of three years. By the time the
drawdown period closed, banks had borrowed 185 billion pounds
worth of UK debt under the scheme.
The SLS had been created at a time of emergency, just weeks
after Bear Stearns collapsed, as tensions were rising about who
might be next. But by early 2010, the Bank of England and Paul
Fisher, the central bank's executive director for markets, were
becoming concerned that banks were not making proper
preparations to pay the money back as scheduled. In January
2010, about 170 billion remained outstanding. RBS owed an
estimated 30 billion.
"The SLS, on top of providing much-needed liquidity
immediately, was also meant to provide banks with sufficient
time to build up extra capital and repair their balance sheets,"
Fisher said. "By mid-2010, we started to have conversations with
the largest banks about how they would exit the scheme and it
became clear that this could not be done smoothly without some
guidance from the Bank."
Fisher told the banks to start raising money again in
private markets, which had reopened. But that implied higher
funding costs - and a further drag on profits. Low borrowing
costs had helped artificially boost profits through 2009, and
now banks were being asked to return to paying the market rate.
The boost to RBS had been clear. In 2008, it paid 9.2
billion pounds in interest on debt it had issued. By 2009, the
bill had fallen to 4.5 billion - and 3.3 billion in 2010. Some
of that reduction had been because its debt pile had shrunk, but
the bank also replaced a huge amount of funding with cheaper
central bank money.
As 2010 came to a close, with business dropping off because
of the eurozone crisis and the cost of funding about to
increase, senior management had to look again at just what was
About this time, Hourican brought in John Owen from Credit
Suisse to take a wide-ranging role dealing with the bank's main
corporate clients - and to look for further areas where the bank
could save money and trim its precious balance sheet. In his
first weeks in the job, Owen asked colleagues to bring him a
spreadsheet of the bank's biggest clients and details of the
return the bank was making from each of them. He was told that
information was not tracked. He was flabbergasted.
"We decided very early on: if we were not adding enough
value to a client to be able to earn a proper return, then we
probably shouldn't have been banking that client," he said. "It
became clear that RBS had the luxury of a substantial amount of
flow and annuity business. That was a wonderful asset, but it
created a challenge. There was a real danger of bankers becoming
complacent and not working hard enough to deepen those
"Also, without the proper understanding of the cost of
capital to the business, deals were done for the sake of it,
rather than because they made a fair return to the bank," he
said. "We had to ensure that we selected our clients and
transactions based on where we could add value and, as a
consequence, provide a return to our own shareholders for the
deployment of the capital and other resources; we could no
longer have any free rides."
As 2011 wore on, the bank extended the exercise and it
quickly became apparent that huge areas that GBM had chosen to
keep hold of after the bailout were making very little money.
Some, like equities, were losing huge amounts of money every
month. Hourican and Nielsen had debated long and hard about
keeping the equity business in early 2009, but the business
hadn't been cut.
According to Nielsen, getting out earlier would also have
proved difficult. "The decision right in the beginning to keep
hold of the equities business was a fiercely wrought one," he
said. "Still, it was a reasonable wager to keep the business.
The markets did come back but the volumes just didn't. Other
banks will testify to that. Back then, we were struggling to
just keep the lights on. Getting out of equities would have been
difficult for management to have accomplished in that
Other parts of the business were performing poorly too. "It
was obvious we weren't making much progress in areas such as
mergers and acquisitions and equity capital markets; we weren't
going to be making substantial progress there any time soon,"
"It was about calling a spade a spade. We took our bets
right off the table when it came to these product areas as well
as in certain geographies, such as Latin America. We were too
far behind the pack and so we were never going to make any money
in places like Brazil where the boom had already reached its
"We reviewed the strategy and did a deep dive into
everything, constantly asking whether the returns we needed
could be met," said Hourican. "By 2011, we were having to work
harder because of increased funding costs, new regulations and
an economic downturn. We executed our strategy doggedly, and
tried to be even tighter than what we had promised the board.
But some things were just outside our control."
Over Christmas 2011, Owen and his team started to draw up plans
to dispose of some more businesses. All the pieces were in place
by February, when the bank announced that it would pull out of
equities and advisory. Upstart investment bank Jefferies had
agreed to buy corporate broker Hoare Govett from RBS. In all,
3,500 people were earmarked to go.
The bank would also scrap the old GBM, splitting the
business in two. The markets division would be a shrunken
version of its former self, focusing on providing mainly credit,
currencies and interest rates market access for the bank's
primary customers. It would be headed by Nielsen. Owen would
take charge of a new international division, which would deal
with globally active corporate clients, providing hedging,
financing and payment management facilities. They would both
report to Hourican.
More than three years after the bailout, a huge amount of
work had been done. The balance sheet has shrunk massively - and
with it, the bank's reliance on wholesale funding markets. From
the 2.2 trillion pounds at the end of 2008, the bank approaches
the end of this year with about 1.5 trillion in assets. In the
GBM division, assets have more than halved and will be cut
further. Capital ratios have also improved massively - from 4
percent prior to the bailout to 10 percent now.
But the intervening few years have been tough, and the bank
is still some distance from meeting some of the top-down tests
that Hester created in early 2009.
One of those was to regain the banks standalone AA rating.
Standard & Poor's and Moody's still regard it as a couple of
notches below that, with few prospects for an upgrade. Also,
Hester's 15 percent return on tangible equity target was cut
back in February to just 12 percent - and only for the core
bank. The third measure - of having a more stable mix - is a
work still in progress. Markets and international now contribute
about a fifth of group revenues.
The years since the bailout have been costly too, with the
bank cumulatively losing almost 31 billion pounds in 2008, 2009,
2010 and 2011, more than what the government injected back in
the dark days of the bailout.
This year, the bank hopes to make its first full-year profit
at group level since it was part-nationalised, but the share
price still languishes well below what the government paid for
its stake. Some have suggested 2014 might be the year the
government sells its stake, but that may be hopeful.
In some ways, however, RBS is well ahead of the pack. Most
investment banks have resisted scaling back their businesses and
concentrating on what they are good at, possibly for fear that a
sudden global economic rebound might be just around the corner.
RBS was forced to concentrate on what it was good at and should
come out of its current (second) restructuring as one of the
more efficient banks in the industry.
Analysts at UBS think the bank is well ahead of its peers in
addressing current regulatory and industry change.
"There is no European bank that has done as much and been
rewarded as little as RBS for the efforts of its restructuring,"
said John-Paul Crutchley and Alastair Ryan.
"However, with 2013 expected to be the last year of
significant restructuring for RBS, it is likely to be one of the
first European banks to have dealt with legacy issues and to
have defined itself around a business model that is capable of
delivering acceptable returns to shareholders in a Basel III
compliant post crisis environment."
For the moment, the decision around the government selling
its stake is out of the hands of RBS's senior management.
Hourican, Nielsen and Owen have now committed to a business
model, which although massively shrunken from the pre-bailout
days of GBM, they believe is the best way ahead. They consider
restructuring to be largely over and done with, and in numerous
interviews restated that their main goal now is to concentrate
on increasing returns. They believe others will have to follow
their deep cuts.
"Going bust isn't the best way to go about these things, but
what happened to us allowed us to be more aggressive in cutting
back quickly, and that put us at an advantage compared to many
of our peers," said Hourican.
"Other banks still have to take the difficult decisions that
we made. They chose not to back then, but will have to make
similar choices. We need to stay relevant, add value and stay
well risk-managed. We aren't planning growth, just on adding
value. We need to be really good in what we are doing."