Royal Bank of Scotland’s (RBS) progress on the long road to recovery could see the bank start to pay dividends by 2018, but any further sale of the shares is likely to be delayed for a year or two by the UK’s decision to leave the EU, according to Ross McEwan, the bank’s chief executive.
The fallout from Brexit, the impact of sustained low interest rates, outstanding conduct issues, the need to further cut costs and to offload the Williams & Glyn business are the main challenges still faced by the bank, which was bailed out by the UK government in 2008 during the financial crisis. The government now owns 73% of RBS, following an initial sale of just over 5% in August 2015.
At the same time, says Mr McEwan, a New Zealander who became CEO in October 2013, RBS has made huge strides in its restructuring and is now well into the second of three phases. The new RBS will focus on the UK and Ireland for 90% of its revenues, is being rebranded to reflect the switch from a global to a domestic bank, has strengthened its IT (which caused the bank huge problems in the past) and has worked out viable models for the payments and markets parts of the business, he says.
Transaction manœuvres
In the case of payments, the bank has withdrawn from the global transactions business, but Mr McEwan says it still carries out one in four of the payments in the UK and deals in 160 different currencies.
“Most of our customers’ needs are either UK- or Ireland-based or western Europe-based. We still deal in multiple numbers of currencies for our customers. I think we can do 160 different currencies on behalf of customers who are trading offshore. We do one in four of the payments in the UK on behalf of our business customers and other customers. So we are big in transaction services,” he says.
“What we pulled out of was global transaction services, where there are six or seven major players. The investment IT-wise [to make the global transaction services business competitive] is very, very high and my view was that for us to put another £500m [$653m] into it to get a 4% return wasn’t good value for our shareholders.
“So we are extracting ourselves out of that marketplace and those customers are going to six or seven other players. But every other piece of transaction services we’re still very, very actively involved in.”
Battered by Brexit
As a consequence of now being a UK-focused bank, RBS’s shares took a hammering following the UK's vote to leave the EU. At the time of writing they were trading at about 190 pence, considerably lower than the 330 pence at which the 5% stake was sold last year and much lower again than the break-even price of 502 pence.
In a wide-ranging interview at the bank’s headquarters in Edinburgh in mid-August, Mr McEwan – who was previously head of retail at RBS, having joined in August 2012 from Commonwealth Bank of Australia – says the bank’s fortunes are a reflection of those of the UK economy so that if, as a result of Brexit, the UK economy slows down, the bank will feel the impact. But he adds that this will not hold up the ongoing restructuring work.
“The point I was making [about Brexit] was that I think the sale of the shares of the Royal Bank will be more difficult in this sort of environment, and it will probably take another year or two for the government to get them all out," he says.
“[The final decision on when to sell] is in the hands of the government. It’s really the Treasury and UKFI [UK Financial Investments] who own the shares: it’s their job to sell them. My job is just to create a good bank, [one] that does make money and has got rid of all the legacy issues so that it’s a great sellable proposition, and that’s what we’re concentrating on.
“[When] we pay a dividend will be when we’ve tidied up some of the big mortgage-backed security issues over in the US, when we’ve removed ourselves from the Williams & Glyn [the name used to refer to the parts of the businesses RBS is required to divest] obligation and we’ve got through, probably, another stress test. So I can’t see a dividend being payable until 2018 at the earliest; we really have to solve those issues first.”
First-half disappointment
Analysts were generally disappointed by the bank’s first-half 2016 results when it lost £2bn, largely due to £1.3bn of litigation and conduct costs and £1.2bn paid to the UK government in order to retire dividend access shares created in 2009 as part of the bail-out. Across the three main businesses – retail, commercial and private banking and markets – the bank reported an operating profit of £2.1bn.
As a result of the 2008 bail-out, under EU rules the bank has been required to sell a number of assets, including the Direct Line insurance arm and Citizens Financial Group in the US, all of which has been done.
But the final asset disposal of Williams & Glyn is proving the trickiest, with the bank now abandoning plans for an initial public offering – even after spending £1.4bn on separating out the IT system – and looking for a trade sale instead. Santander is considered the most likely buyer.
But with the UK set to leave the EU, could RBS now ignore this EU stipulation?
Mr McEwan says: “The rules are the rules and I think we should stick with the rules. And one of the requirements for us was to extract out small and medium-sized enterprise [SME] capability and create more competition in the marketplace. And that’s what the removal of the Williams & Glyn assets actually does, because it’s actually an SME bank more than it is a retail bank.”
Stressed out
The other hurdle cited by Mr McEwan before dividends can be paid is clearing an EU-wide stress test. In the last result put out by the European Banking Authority in late July, RBS was found to take the third biggest capital hit out of 51 banks under a stressed scenario.
“Well, first off I think that you’ve got to look at the starting point," says Mr McEwan. "We started at 15.5% common equity Tier 1, which was actually one of the highest not just in the UK but also in the EU. And what it showed was that we still have a number of issues that we need to address that are all out, very publicly, in the marketplace. The mortgage-backed securities in the US is an [issue] we need to take into consideration with our capital.
“When you take those items out we ended up with just over 8%, which is a very good position to be in. So people took it as ‘my goodness there’s a problem here’, when actually, all it shows is we’ve built capital knowing that we will be paying out a lot on these issues.”
The problem with the conduct issues is that they are being dealt with in a timeframe the bank does not control. A battle by shareholders to get compensation over what they claim was misinformation at the time of a 2008 rights issue – something the bank denies – could drag on to 2023, says Mr McEwan. Meanwhile, the deadline for claims for the mis-selling of payment protection insurance in the UK has been extended to June 2019.
“The big one for us is [mis-selling allegations in the] mortgage business we wrote in the US back in 2003 to 2007. So this dates back many years now and is still yet to go through the Department of Justice. So that one is not in my time gift but it is one of the big issues facing us.”
Cutting costs
At the time of its collapse, RBS was one of the largest banks in the world, with extensive international and investment banking operations. While it used to operate in 50 countries it now works in 13, the investment bank has taken radical surgery and billions of pounds-worth of assets have been disposed of.
Now the challenge is to achieve a cost base to match. Currently the bank's cost-to-income ratio is 72%, but Mr McEwan’s target is less than 50%.
“This bank does need to cut costs. It was a global titan – I mean, it was the largest bank in the world and it’s got a cost structure that’s sort of associated with that. So we have been taking the costs out. In my first year, 2014, we took out £1.1bn of true costs, not [counting] when we’ve sold businesses. [This was] actual true cost out of our cost base.
“The year after we took £984m. This year we said we will take out £800m, so you’re really looking at nearly £3bn over a three-year period of time. It’s a big amount of costs and we’ve still got a lot of work to do. The issue is our income is coming down as we get out of businesses.”
Apart from withdrawing from global transaction services, RBS has undertaken a dramatic resizing of its capital markets business and now focuses on just three areas: foreign exchange, rates and debt capital management.
Mr McEwan says: “My view when I took over was, if you have that size of [investment banking] business you have to get a return out, and I couldn’t see us getting returns out of it and I couldn’t see us being significant in all the parts of those markets we were in. So [I wanted to] get back to things you’re good at, that you’ve got good strategic positions [in] and it’s proved, I think, to be right so far. In the sense you’re seeing a lot of other banks try to find their own shape in this marketplace, well, we’ve found ours.”
Mulling deposit charges
But growing income is going to made more difficult by a prolonged low interest rate environment following the Brexit vote, and RBS has gone as far as discussing how it would cope in a negative interest rate scenario.
“When you look at what’s happened in Europe, where interest rates have gone negative in some countries, you do need to be in the position, if you need to, to actually charge customers [for holding their deposits]. And what we found was that our terms and conditions didn’t allow it.
“Now I’m not saying we’re going to do it, but we need to have the ability to be able to charge negative interest rates if they go there, otherwise it costs the bank a lot of money to support deposits.”
At the same time as this huge restructuring has been taking place, RBS has had to come to terms with new demands from customers for online and mobile banking. Legacy IT systems have not made this task easier.
Most significantly, some UK banks suffered a major IT failure in 2012, when millions of customers were unable to access their accounts. RBS was fined £56m by the regulators as a result. Since then, the bank has invested heavily in IT and has become a pioneer in some aspects of digital banking, such as introducing the first fingerprint security in the UK for mobile banking. It is also rebranding in a way that works with its new UK focus rather than the old global one.
Beefing up tech
On IT, Mr McEwan says: “In 2012, we did have an issue and we’ve strengthened our IT resilience. You look at what’s happening in the bank [now] – we very, very seldom have any difficulties. But we are plagued with a memory that people have.
“You have to have good technology, and this bank has fantastic technology. Our problem is because of the way it was constructed – [the bank’s] just got too much of it. So one of our issues is: how do you get less technology that is fantastic technology? And that’s what our technology team are working on.
“That’s why we were able to be first in the market with touch ID. We’ve been very, very strong in mobile, very strong in online for our business customers as well, through a product called Bankline that can do all sorts of facilitation for corporate customers.”
“We were also one of the first, on the markets side of the business, to allow customers just to do the trades themselves. Some of the rate trading is now done at customers’ desks as opposed to [in the bank]: it’s electronic, straight-through, nobody touches it. We’ve actually been a strong leader on the technology front and that’s what we’ll have to continue to be.”
From global to local
Regarding RBS's rebranding, Mr McEwan says: “Prior to my time, we had a global operation and for a global operation we had a global brand and that was RBS, which was known all around the world because of the positioning of that brand. But as you come back to being a local UK and Ireland business, what you need is local brands for those marketplaces. We’ve clearly said for Ireland it’s going to be Ulster Bank, for England and Wales it’s going to be NatWest and for Scotland it’s going to be back to the Royal Bank of Scotland.
“We are a large player in the domestic retail market. We’re the largest SME player in the UK. We’re the largest mid‑market commercial bank and we’re one of the largest corporate banks in the UK. So this is where our fantastic franchises are and that’s why the concentration needs to be here so that we can deliver up to those great customer groupings.”
If the bank does begin paying dividends in 2018, it will have been a 10-year haul from its collapse in 2008. How much longer it will take for the share price to reach a break-even point is a matter of conjecture, but at least the strategy is clearly defined and the essential pieces are in place. The problem, as Mr McEwan freely admits, is that not everything is under his control timewise. RBS still has some painful days ahead before it can really settle down to business as usual.
