RBS Shares Tank As U.K. Banking Commission Chair Supports Splitting The Bank

The debate on whether The Royal Bank of Scotland Group (NYSE:RBS) should be split into a ‘good’ bank and ‘bad’ bank heated up this Tuesday when British Member of Parliament Andrew Tyrie demanded a thorough review of all aspects of the proposed split before dismissing the possibility of such a move. ^[1] The U.K. government, which owns a majority stake in the global banking giant since it was bailed out in 2009, has been pondering ways to dispose of the stake in a manner that puts the least risk on taxpayers’ money. Tyrie, who chairs the Parliamentary Commission on Banking Standards, put his weight behind the regulatory commission’s recommendation of splitting the banking group.

In the recent past, investors and analysts have expressed concerns that separating all the poorly performing assets into a separate public entity will not only be a cumbersome process, but the required accounting considerations could result in a steep loss of value for the assets. In the letter, Tyrie tried to alleviate these concerns by saying the split “does nothing to alter the underlying position of the economy, the public sector’s net worth, or the future burden of taxation.” This message did not have the desired impact on investors though, as growing uncertainty about RBS’s future triggered a sell-off in its shares, sending them almost 6% lower over the day.

We maintain a $11 price estimate for RBS’s stock, which is at a premium of about 10% to current market prices.

See our full analysis for RBS’s stock

Since its £45.5 billion bailout in the aftermath of the global economic downturn of 2008 – the largest for any bank in the world – RBS has been struggling to return to profitability due to weak economic conditions in Europe coupled with the billions in settlements and charges it has incurred on legacy issues over the period. With its share price remaining depressed since then, the choices before the British government are either to begin selling the RBS stake at a loss, or to actively implement changes in the bank’s structure to help share value appreciation in the near future. No surprise here that the British government chose the latter.

Now, one of the most debated solution is a proposed splitting of the bank into a “good bank” which houses the core operations largely focused on retail and commercial banking services in the U.K., and a “bad bank” which will have all the non-core business units that have been running into losses and are not likely to return to profit anytime soon. This is not very different from what was successfully implemented by Citigroup (NYSE:C) through its reorganization into Citicorp and Citi Holdings.

However, the plan for RBS ran into issues when initial reports claimed that the separation process would be cumbersome and that the costs incurred would undermine the benefits from actually going through with the split. Also, the process of splitting the bank would require RBS to reassess the value of some assets on its book – which would lead to billions in accounting-related losses.

And while the British government remains in two minds on going ahead with the mammoth task of breaking up RBS, the underlying political undertone has seen several politicians bringing this matter to the fore. With the government waiting for a full report on the feasibility of this move due this autumn, what remains to be seen is what path it finally chooses for RBS. ^[2] Until then, the uncertainty over its future is bound to lead to continuing fluctuations in the bank’s share price.

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1. All aspects of an RBS split must be examined, Financial Times, Aug 27 2013 [↩]
2. Ulster Bank split from RBS urged in lending boost plan, Belfast Telegraph, Aug 27 2013 [↩]