RBS - NEW STYLE HAIRCUT FOR BANKS

As Fred Goodwin was "Fred the Shred", Stephen Hester must be "Stevie the Sweeney" (as in Sweeney Todd the Demon Barber). Never has a bank CEO had to 'fess up to so many bloody 'haircuts' at one time, and all in the name of doing justice to proper accounting standards and rigorous risk management! There is great shape and style to this. Where Hester and RBS lead other major banks will have to follow.
RBS is one of the world's very biggest banks. It's balance sheet is the size of the UK's GDP. Its writedowns and loan loss provisions represent the biggest loss in UK history, but even so that is only 1.6% net of the balance sheet. Ten times more than this is being cut away from the core business and offered for sale and work-out in a 'non core division' and the same again offered for warehousing in a UK Government 'bad bank' scheme, and roughly the same again will be swapped at the Bank of England's Liquidity Window. That's a third of the balance sheet. The headshop topiary involved in this is awe-inspiring and will be closely scrutinised around the world by other banks and governments and financial authorities.
Shifting my metaphor to an all-time classic movie, if RBS under Fred the Shred was a prime example of leading banks into the Heart of Darkness, he ended up like like Colonel Kurtz in Apocalypse Now with this annual report's explosions lighting up the night sky with statutory £40bn gross loss before tax and provisions, "OH, THE ERROR, THE ERROR!". If Goodwin is Kurtz (above), Hester is Capt. Ben Willard (pictured below), sent in by the generals to kill Col. Kurtz and bravely call in the air-strikes, while Alistair Darling is perhaps another Colonel Kilgore (pictured below) who says, "I love the smell of napalm in the morning... The smell, you know, that gasoline smell, the whole hill. Smells like - victory. [A bomb explodes behind him.] Some day, this war's gonna end." On cue, UK banks' share prices lit up in the jungle of the FTSE 100 today in double-digit rises for banks and other financials before the afternoon's profit-taking, and as government plans to help free up funds for lending were well received on top of the ruthless pruning of the RBS balance sheet. RBS results and plans involve by my reckoning over a third of the balance sheet restructured, which is much more significant than the £28bn pre-announced, now £27bn, loss for 2008, even if a record for a UK company. RBS's annual report is stunning. Never have I seen such a bold, spare-no-detail, flannel-free annual report from any major company. That is not to say, however that the accounting does not have hidden depths, how could it not with such big numbers. On the one hand it taps Treasury for £25.5bn, which neatly covers the writedown plus the effective haircut on asset swaps into the new 'bad bank' (subject to shareholder approval i.e. the Government's 68%) thereby delivering the same again in net asset value to the Government. The £16.6bn goodwill writedown has to be generated somewhere and since it cannot all be £10bn purchase price of RBS's share of ABN AMRO, I think the answer includes £6.6bn to HM Treasury in the bad bank complex of asset swap and more capitalisation, making RBS one of the best capital reserve ratio banks in the world.
This £25.5bn further infusions from HM Treasury comes on top of the £60bn collateral margin and haircut from UK banks via the Bank of England SLS and net £10bn recovered from bailouts so far, adding up to a government off-budget funding capacity total of about £100bn to which there will be added another £60bn in 2009 via "son of SLS", plus another £50bn or so via 'bad bank' and likely market value gains of maybe £50-100bn during the year from UKFI shareholdings in the banks.
Under the terms of the Government's 'bad bank' protection scheme worth up to £500bn (which the Americans are also emulating in TALF that is likely to grow to several $trillions), the UK government will insure troubled assets held by British banks with 6% downside protection, 2% annual fee and over 1% upfront fee (classy SIV negotiating style here). RBS said it planned to participate in the programme, registering assets with a par value of £325bn. The £500bn may be deemed by the Office of National Statistics ONS as liquid assets insofar as offsetting the £1tn in debt liabilities that it is intending to formally add to the UK National Debt? There was immediate market relief that it looked to be enough to prevent another full nationalisation in the sector. This is definitely the way to go, and as the RBS Annual Report says is delivering a profitable return for Government (taxpayers) - very profitable I would say worth over the medium half or more of the Government's annual budget deficit. Those who go on about 'hard choices' forget that there are also 'soft choices'. But what this reminds me of is the originate-to-distribute model whereby as the Chairman of BIS BCBS and other top regulators said in speeches up to 2 years ago, the world of banking is dividing into three 'business models'; the global banks to provide finance, a middle tier to package financial products and a third, retail tier, to distribute and sell. What they did not envisage was that the top tier would not be the global commercial banks, but Government Treasuries and central banks, appropriately 'the lenders of last resort'. Taking on the liquid and illiquid assets (large chunks of banks' loan-books), providing treasury bills for funding of banks' fuinding gaps, and supplying much of banks' capital reserves is over the cycle a very profitable business. Central banks and treasury departments (finance ministries) are providing the central money market intermediation, the warehousing of securitisations and structured product financing, and also displacing shareholders. The private funding sources that panicked in the credit crunch or closed down for new business will now be scrabbling to get back in but may find they are shut out and will have to be content with the crumbs off the government's table for the next 3-5 years!
The RBS annual report again and agin refers to dislocation of funding and high cost of funding, but including the market spread and haircuts exerted by the bank of England's SLS, the higher cost of funding was only £130m compared to 2007! Clearly, funding cost was relatively trivial; the real problem was access to funding. Traders and analysts now say there ss the chance for the market to move away from the worst of the financial crisis, with RBS’s record loss (£40.7bn gross loss before tax) as a grim purgative on the tombstone-fringed road to recovery.