RBS Eyes Complete Exit From U.S. Mortgage Trading Business

RBS: Royal Bank of Scotland Group logo
RBS
Royal Bank of Scotland Group

Five months after announcing plans to cut hundreds of jobs in its U.S. mortgage trading unit, The Royal Bank of Scotland Group (NYSE:RBS) has reconsidered its decision and is now looking to shutter this unit. [1] The U.K.-based banking group, which is majority-owned by the British government, had initially hoped to trim this business to one-third its size over the next two years, but it will now exit its mortgage backed-security, commercial real estate and commercial mortgage bond sales and trading operations completely over the same time frame.

RBS announced plans to reduce nearly 400 jobs in its trading and mortgage businesses in the country along with plans for an IPO of the Citizens Financial Group this May (see Why RBS Is Likely To Retreat From The U.S. Market). The move in itself was the result of increasing pressure on RBS from the British government to focus on its retail and commercial banking operations in U.K. over recent years, and the Federal Reserve’s directive for the bank to shore up the balance sheet for its subsidiary in the U.S. only accelerated the retreat.

We are in the process of updating our $13 price estimate for RBS’s stock, which is about 10% above its current market price.

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See our full analysis for RBS’s stock

RBS arguably underwent the most extensive reorganization among all the global banking giants in the wake of the economic downturn, with the bank reducing total jobs across its operations from 226,400 at the end of 2007 to less than 113,000 at the end of Q3 2014 – a reduction of more than 50% over this period. A large part of this downsizing was mandated by the European Commission (EC) as a condition for RBS’s bailout. However, in recent years it was also driven by a strategic shift from a highly diversified business model to one focused on retail and commercial banking operations in the U.K. due to sustained pressure from the British government. A gradual spin-off of the group’s operations in the U.S. was announced early last year, and the bank’s sale of a 25% stake in Citizens this September was the biggest step in this direction.

RBS’s decision to shrink several capital-intensive U.S. operations most likely stems from the bank’s need to escape the additional scrutiny which foreign bank subsidiaries with over $50 billion in assets draw from the Federal Reserve. The Fed included RBS Citizens as a part of the tests conducted this year, along with the U.S. subsidiaries of all foreign banks with more than $50 billion in total consolidated assets, and found the unit’s capital levels inadequate. Compliance with U.S. capital ratio requirements will require a capital infusion of several billion dollars into the U.S. subsidiary – something that RBS would like to avoid as it works on strengthening its overall capital structure, given that it already lags other banking giants in terms of common equity Tier 1 (CET1) capital ratio figures.

As a solution that helps it avoid the Fed’s stress tests and also falls in line with the British government, RBS is now looking to shrink its asset base in the U.S. to under the $50 billion mark. Consequently, the bank will likely reduce operations in the country to the bare-minimum levels required to offer international banking services to its clients over coming years. The recently announced plans to exit the U.S. mortgage trading business makes sense in this regard due to its high capital requirements. While RBS will exit mortgage backed-security, commercial real estate and commercial mortgage-bond sales and trading completely, it will retain its non-mortgage asset backed securities.

The move will affect RBS’s fixed-income, currencies and commodities (FICC) trading revenues in the long run. You can understand how this influences RBS’s total share value by making changes to the chart below, which captures this revenue source.

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Notes:
  1. Royal Bank of Scotland to exit U.S. mortgage business, Reuters, Nov 14 2014 []