It looks increasingly likely - almost inevitable - that many of Europe's leading banks will need fresh dollops of capital. And, miserably, the Royal Bank of Scotland (RBS) is likely to be in the queue. Miserable, because RBS has already had a £45bn injection of capital from the UK state, leaving the government owning 83 per cent of its equity, and, as recently as June, the bank reported an apparently healthy ratio of 11.1 per cent of so-called Core Tier 1 capital (essentially equity) to risk-adjusted assets. But, as banks face the likelihood that the book value of their holdings of sovereign debt in the eurozone's floundering states has to be, perhaps, halved, fears are growing that RBS's capital may prove insufficient.
- May need another capital injection
- Rating agency downgrades
- Regulatory uncertainty
- Grim economic backdrop
- High ratio of retail deposits
- Bad debts fell in the first half
Those fears are understandable. Go back to July, when the European Banking Authority (EBA) was stress testing Europe's banks to see how they would cope in a prolonged recession, RBS's result looked shaky. Under the EBA's scenario, RBS's Tier 1 ratio came out at just 6.3 per cent, the poorest of the big UK lenders. The bank is one of the most exposed in the UK to the weakest eurozone countries, too. The stress tests revealed that RBS held €1.15bn (£1bn) of Greek debt, €4.6bn of Italian, €402m of Irish, €208m of Portuguese and €379m of Spanish. Now that the EBA is rerunning its stress tests to apply hefty discounts to sovereign bond holdings - bizarrely, it failed to do so in July - then RBS's shock-absorbing capacity may end up being weaker still. Investment bank Credit Suisse has estimated that RBS may need an extra £16.9bn of capital, in which case full nationalisation would be hard to avoid.
Matters weren't helped when rating agency Moody's downgraded the credit ratings of 12 UK lenders earlier this month, including RBS. Fitch, another rating agency, followed by downgrading the ratings of Lloyds and RBS. Admittedly, that has much to do with expectations that lenders are less likely to receive state support following the final recommendation from the Independent Commission on Banking (ICB) last month. Even so, it has further depressed sentiment towards RBS's shares.
Besides, the regulatory implications arising from the ICB's report raise long-term uncertainties for RBS. That's because RBS has a big investment banking operation - its Global Banking & Markets unit - and the ICB wants banks to ringfence their investment banking operations from their high-street banking side. "The report is not great news for RBS and Barclays as the ring fence will have a major impact on their operations," says Nic Clarke, a banks analyst at broker Charles Stanley.
ROYAL BANK OF SCOTLAND (RBS) | ||||
|---|---|---|---|---|
| ORD PRICE: | 24.2p | MARKET VALUE: | £26.3bn | |
| TOUCH: | 24.2-24.3p | 12-MONTH HIGH/LOW: | 49.5p | 19.6p |
| DIVIDEND YIELD: | NIL | PE RATIO: | NA | |
| NET ASSET VALUE: | 69p | |||
| Year to 31 Dec | Pre-tax profit (£bn) | Earnings per share (p) | Dividend per share (p) |
|---|---|---|---|
| 2007 | 9.64 | 64.0 | 27.0 |
| 2008 | -25.69 | -146.2 | nil |
| 2009 | -2.65 | -6.3 | nil |
| 2010 | -0.40 | -0.5 | nil |
| 2011* | -0.56 | -1.2 | nil |
| % change | - | - | - |
Normal market size: 100,000 Matched bargain trading Beta: 1.9 *Evolution Securities estimates (earnings not comparable with earlier figures) | |||
Economic downturn is another big worry. As the economy slows - and a return to recession looks a distinct possibility - then defaults could increase, leading bad debts to rise. Moreover, the weakened demand for credit that accompanies recession would be bad news for profits. The problem could be exacerbated should RBS seek to mitigate concerns about its shortage of capital by lending less. That said, there are no signs of such trends emerging yet. At the half-year stage, for instance, RBS reported that its bad debt charge had actually fallen 2 per cent in the year to end June to £5.1bn.
Moreover, RBS's funding position doesn't look too bad, even though the wholesale money markets are freezing up as fears over exposure to dodgy eurozone sovereign debt make banks increasingly cautious about lending to each other. At the half-year stage, for instance, RBS had £429bn-worth of deposits from customers, enough to fund almost 80 per cent of its £546bn of loans. Essentially, RBS isn't overly reliant on wholesale funding, unlike some struggling French and Italian banks, although the backdrop of a malfunctioning interbank market depresses sentiment towards all banks' shares.
