At the Royal Bank of Scotland, the business of rescuing the world’s worst bank


Pedestrians pass the headquarters of the Royal Bank of Scotland (RBS) in Moscow, Russia, on Wednesday, April 17. (Andrey Rudakov/Bloomberg)
April 20, 2013

Rory Cullinan runs the world’s worst bank from a fifth-floor office overlooking Liverpool Street station in London. His 400-person outfit doesn’t lend money or trade securities. Instead, it sells blown-out mortgages, busted loans and entire companies amassed by Royal Bank of Scotland Group before it collapsed in the global financial crash of 2008. On a Friday afternoon, Cullinan is savoring a new feeling in his life as a toxic-asset disposal specialist: hope that the worst is finally over.

After four years of marathon dealmaking, Cullinan’s Non-Core Division has whacked a 258-billion-pound ($390 billion) financial junk pile down to 57 billion pounds and eased pressure on RBS’s balance sheet. That has been chief executive Stephen Hester’s top priority since the government saved RBS from insolvency beginning in late 2008 with a 45-billion-pound lifeline — the biggest bank bailout in history.

“RBS was obviously bankrupt, and there was a lot of tension, a lot of chaos, and I was living in here,” says Cullinan, 53, a silver-haired Scot. “Now, it’s a paragon of calm.”

While Cullinan’s so-called bad bank has made progress, Hester, 52, faces turmoil in almost every other part of RBS as he struggles to return the firm to profitability and pay back taxpayers.


Rory Cullinan, head of RBS's Non-Core Division, has sold everything from branch networks in Romania to a chain of pubs in the U.K. to restore the bank's balance sheet. (Neil Gavin)

No British megabank drained its capital and piled on more debt to swallow rivals than did 286-year-old RBS. And no lender has saddled citizens with a heavier burden. The state, which holds an 82 percent ownership stake in RBS worth 24.6 billion pounds, was sitting on a 20.4-billion-pound paper loss as of April 3.

Almost five years after RBS’s rescue, a growing chorus of investors, politicians and academics has concluded that the bank is too damaged to bounce back in its current form. From 2008 to 2012, RBS lost 37 billion pounds as it wrote down bad assets and revalued its debt.

“Taxpayers are still not getting a return on their investment,” says Ismail Erturk, a senior lecturer at Manchester Business School. “RBS should be broken up and not left to current management.”

The RBS mess has pitted Chancellor of the Exchequer George Osborne, who continues to stand behind Hester’s turnaround plan, against Bank of England Governor Mervyn King, who says it is not working. King told the Parliamentary Commission on Banking Standards that the government should fully nationalize RBS, then split it up and re-privatize the “good” pieces of the bank to recoup what it can of the bailout.

“We should simply accept the reality today that it is worth less than we thought and should find a way to get an RBS that can be useful to the U.K. economy,” said King, 65, who will retire June 30.

Hester has told investors and analysts that getting a grip on RBS has proven a far tougher task than he expected because the euro zone’s sovereign-debt crisis and two recessions in Britain have undermined the bank’s bedrock lending business. Hester has also been hit with misdeeds that took root before he arrived at the bank.

In February, RBS agreed to pay a $612 million penalty to regulators and law enforcement officials in the United States and Britain to settle allegations that 21 of its traders had manipulated the London interbank offered rate, or Libor, from 2006 to 2010. Barclays paid a $453 million penalty in July to settle its Libor case, and UBS was fined $1.5 billion in December.

On April 3, a group of 12,000 RBS stockholders filed a lawsuit in London alleging the bank unlawfully inflated the strength of its capital position when it sold 12 billion pounds worth of new shares in spring 2008. The suit, which may seek as much as 4 billion pounds in claims, comes a week after a separate group of investors filed a lawsuit in London making similar allegations over the share offering. RBS spokesman David Gaffney declined to comment on either suit.

Hester has vowed that 2013 will be the final year of major red ink for RBS, thanks to Cullinan’s handiwork.

“We are coming much closer to the end of the restructuring phase of RBS than we have been,” Hester said on a Feb. 28 conference call after the bank released its 2012 results — a loss of 6 billion pounds on 26 billion pounds in revenue. “I do think the toughest work in recovering RBS is behind us.”

Since Hester and Chairman Philip Hampton started restructuring RBS in 2009, the strategy has been to shift the focus of the universal bank toward the British market, to retail and corporate lending.

Gone are RBS’s ambitions to rise as a global investment-banking power. In 2007, RBS drew about half of its operating profit from underwriting securities, trading, cash management and other investment-banking activities. As the crisis hit the following year, investment banking lost almost 11 billion pounds. Last year, Hester eliminated 3,500 jobs as he finally chucked major pieces of the division.

Bruce Van Saun, RBS’s group finance director, says he and Hester are nearing their goal for realigning the bank. They are striving to reduce investment banking’s portion of RBS’s operating profit to 20 percent, from 24 percent in 2012, and boost retail and corporate lending to 80 percent, from 67 percent last year. Later this year, Von Saun may leave his job to head RBS’s Citizens Financial unit in the United States as it prepares to sell 20 to 25 percent of the company in an initial public offering, according to a person with knowledge of the potential move.

Hester isn’t done firing people. Van Saun says the bank plans to announce a smaller round of job cuts in investment banking in July as it continues to reorganize the division to help corporate clients such as BP and GlaxoSmithKline raise capital and hedge currencies and interest rates.

In all, Hester has announced the elimination of 36,000 jobs — slicing the workforce by 39 percent from its peak in 2007. RBS, with 1.3 trillion pounds in assets as of December 2012, is still a sprawling enterprise with 137,200 employees.

“You have to make some hard decisions about where you’re going to play,” says Van Saun, 55, a Virginia native. “You still need to offer basic services that corporations need, but we don’t want to be in investment banking just for the fun of it.”

As a ward of the state, the bank should be lending more to British companies in a time of economic hardship, says Nigel Lawson, who was Margaret Thatcher’s chancellor of the Exchequer from 1983 to 1989.

“Lending to small and medium-size businesses is the most important contribution the RBS group can make,” says Lawson, a Conservative member of the House of Lords. “That is not Hester’s background at all; he’s an investment banker.”

Van Saun says RBS isn’t being stingy. The bank says it accounts for more than a third of the loans made to British companies with less than 25 million pounds in annual revenue. He says it’s hard to find borrowers with the collateral and sales growth to qualify for credit in an economy that contracted 0.3 percent in the fourth quarter.

“We want to make loans,” he says. “We would be making more money if there were more lending opportunities out there.”

British Business Secretary Vince Cable says banks such as RBS aren’t trying hard enough to lend to small and medium-sized companies. “I don’t take that argument seriously,” Cable, a Liberal Democrat, said in a speech Feb. 6. “That’s just lazy and rather ridiculous, to be frank.”

Cable, King and Lawson say the prior Labor Party government made a mistake by not taking a stronger hand in managing RBS and directing it to boost lending. To allay investors’ concerns that RBS would be ruled by government fiat after the bailout, then-prime minister Gordon Brown agreed not to direct Hampton and Hester in how to manage the bank. His successor, Conservative David Cameron, stayed the course.

“The whole idea of a bank being 82 percent owned by the taxpayer and run at arm’s length from the government is nonsense,” King told the banking standards commission.

Osborne told the commission that Hester is right to keep RBS intact. The chancellor said British banks must maintain their heft and services to cater to global corporations or they will lose out to foreign rivals. Osborne said it was wiser to let Hester finish what he had started rather than have the government spend billions of pounds to buy out RBS’s minority shareholders and take total control of the bank.

“You have to weigh the upfront costs, the complexity of separating the bank,” Osborne said. “You would have to weigh that against current strategy, which is to take the Royal Bank of Scotland and greatly reduce its assets and its ambition from being a global universal bank.”

Even so, Osborne is searching for ways to shake loose what commission member Susan Kramer called his “albatross” at the Feb. 25 hearing. RBS’s stock closed at 271 pence on April 3, 46 percent below the average 502 pence the government paid when it bailed the bank out in 2008 and 2009.

This year through April 3, RBS shares fell 16 percent compared with a 9 percent surge by the FTSE All-Share Banks Index, which tracks Barclays, HSBC, RBS and three other British lenders.

The business secretary has urged the government to consider a novel solution for getting RBS back into private hands. He wants to give away the state’s 9.1 billion shares to Britain’s 45 million taxpayers. Members of the public would register to receive RBS shares valued at a floor price established on the day of the grant.

To curb a wave of immediate selling, stockholders would be able to pocket gains only above that price. The difference would go to the Treasury. Osborne is considering the plan as a possible exit strategy, a Treasury spokesman says.

Hester is still cleaning up the mess left behind by former RBS CEO Fred Goodwin, who mounted the 73-billion-euro ($94 billion) hostile takeover of Amsterdam’s ABN Amro Holding in October 2007 based on due diligence that largely comprised two binders and one CD of data, according to a 2011 report by the Financial Services Authority.

Goodwin used 12.3 billion euros in debt that came due in less than a year to help finance the biggest acquisition in banking history. His move compounded RBS’s day-to-day reliance on short-term funding as liquidity in global credit markets was evaporating, driving the bank to the brink of insolvency.

Last year, Queen Elizabeth II stripped Goodwin of his knighthood. Retired from finance, Goodwin, 54, collects an annual pension of 342,500 pounds.

Hester has weaned RBS from short-term notes to protect the bank from another liquidity crunch and bolster confidence in its balance sheet among credit-rating firms. In December 2012, RBS’s short-term wholesale funding was 42 billion pounds, or 5 percent of its balance sheet, compared with 297 billion pounds, or 24 percent, in 2008.

And he boosted the bank’s Tier 1 capital ratio, which measures its financial strength, to 10.3 percent from 4 percent, excluding Cullinan’s Non-Core unit.

Hester has said his key move was selling off the mountain of money-losing and unwanted assets RBS had piled up in the decade before the crash. For that job, he turned to Cullinan, a buyout specialist who had been roaming Africa and Russia for deals as co-managing partner of Renaissance Capital, a Moscow-based investment bank.

In addition to disposing of mortgage-backed securities and loans, Cullinan had to unload a raft of companies: branch networks in Romania, luxury hotels in London and even a chain of 918 pubs. As he hunkered down in a corner office, Cullinan cast a droll eye on the cone-shaped skyscraper known as the Gherkin and the other towers of London’s financial district that loomed outside his window. He had tacked a cartoon to his wall that captured the spirit of his new job. “As you can see,” a realtor says to a client admiring the same skyline, “this property has excellent views of the recession.”

Rather than hold a fire sale, Cullinan assembled a team of more than 600 bankers, traders and analysts and spent 2009 determining the intrinsic value of every mortgage security, loan and asset in his bulging portfolio.

“The great fear was that when they divested, they’d get the wrong prices because they were forced sellers,” says Paul Mumford, senior fund manager at Cavendish Asset Management, which holds 500,000 RBS shares. “They’ve done a reasonably good job under the circumstances.”

“There is light at the end of the tunnel, and we expect RBS to look like a normalized bank in 2014, with a good capital position and a clear dividend policy in place,” Van Saun says.

Investors aren’t as optimistic. RBS is even having trouble keeping its computer systems running. Millions of retail customers lost access to their accounts last June and again in March. And the bank isn’t done reckoning with the early misconduct.

The bank has paid out or set aside more than 2.5 billion pounds to settle claims that it ripped off small businesses and individual borrowers with flawed interest-rate swaps and payment-protection insurance before the 2008 credit crunch. Lloyds Banking, Barclays and HSBC have also allocated billions of pounds to pay out claims in similar cases.

“Hopefully, there are no other horrors looming in the woodwork,” Mumford says. “But nothing would surprise me.”

The full version of this Bloomberg Markets article appears in the magazine’s May issue.

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