Why RBS May Have To Sell Williams & Glyn To Santander

Working against a deadline of year-end 2017 to dispose of its Williams & Glyn unit, The Royal Bank of Scotland Group (NYSE:RBS) may have to accept a lower bid from Santander even if Clydesdale & Yorkshire Bank (CYBG) offers a better bid. This is because Clydesdale’s ongoing struggle to maintain profitability will result in a deal with RBS attracting significant scrutiny from British financial regulators. ^[1] The ensuing regulatory review would delay the sale at the very least, and could eventually be rejected by regulators – forcing RBS to scramble to find a buyer at the last minute. In any case, a deal with Clydesdale doesn’t appear likely within RBS’s short timeframe.

Such a situation does not bode well for the banking giant in which the British government holds a 73% stake, as the divestiture was one of several conditions laid out by the European Commission (EC) for RBS’s bailout in 2009. RBS has already received an extention of four years, and failure to close the deal in time will force the EC to intervene. That said, a sale to Santander is also not without its problems, as the Spanish bank has walked away from the deal twice over the years – the first time in 2012 and again as recently as this September. ^[2] Santander’s submitted its latest bid for Williams & Glyn earlier this month – making it the third time the Spanish bank is pursuing a deal. ^[3]

Given the urgency of the sale process, we believe that RBS will likely ink a deal with Santander as soon as possible, even if such a move entails writing off a few hundred million pounds. This presents a potential downside to our price estimate of $6 for RBS’s stock, which is a premium of about 15% to current market prices.

See our full analysis for RBS’s stock

In return for its £45.5 billion bailout in the aftermath of the global economic downturn of 2008, the EC laid down a list of restrictions as well as compulsory divestments that RBS had to undertake over following years. ^[4] One of the requirements was the disposal of 308 RBS branches in England & Wales and 6 NatWest branches in Scotland which focused on certain SME and corporate activities – dubbed Project Rainbow. ((Statement on disposal of UK Branch-based Business, RBS Press Releases, Oct 15 2012)) While RBS had no trouble adhering to the other requirements, Project Rainbow proved to be troublesome.

It started with Santander backing off from the deal in late 2012 – a good two years after announcing its decision to acquire the branches – due to technology and separation-related complexities. ^[5] With little time on its hands, RBS started from scratch and vetted the proposals it received for almost a year before finally zeroing in one from Corsair Capital, Centerbridge Partners, the Church Commissioners for England and RIT Capital Partners. The deal resulted in the creation of Williams and Glyn, which was recapitalized with debt of £600 million. After that, RBS spent £1.4 billion over 2014-15 in creating a new technology platform for Williams & Glyn so that the division could be spun off. However, plans for a spin-off had to be abandoned in August, as continuing technology issues and poor equity market conditions in the wake of the Brexit vote made separating Williams & Glyn an untenable proposal. ^[6] At this time, RBS reinitiated talks with potential buyers for Williams & Glyn – including Santander, and more recently Clydesdale.

The fact that RBS is leaning in favor of a deal with Clydesdale would indicate that the latter is quoting a figure for Williams and Glyn which is close to the £850 million RBS is looking for from the sale. ^[3] It should be noted that Williams and Glyn is currently valued at around £1.3 billion, and RBS has also spent roughly £2 billion on the unit to prepare it for a divestment. So the sale is already a loss-making proposition for RBS, and Santander’s proposal values the unit well below what Clydesdale apparently did.

But a deal with Clydesdale faces an additional difficulty – stricter regulatory scrutiny. Clydesdale is currently working on a plan to cut costs to ensure profitability, and a merger with similar-sized Williams & Glyn could be problematic. In fact, British financial regulators have already made their concerns about a potential deal with Clydesdale clear by getting a third party to review the merger. A deal with Santander would not be subject to this problem, and appears to be RBS’s best bet to dispose of Williams & Glyn by the end of 2017. Because of this, we believe that RBS may be better off inking a deal with the Spanish banking group in the interest of time – even if the deal adds to an already large loss associated with the disposal.

RBS reports results for Williams & Glyn as a part of its non-core operations. The impact of a one-time loss on our price estimate for RBS can be understood by making changes to the chart below which captures our estimates for the bank’s non-core operating margin.

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1. Watchdog to hire bankers to review Williams & Glyn sell-off attempt, The Telegraph, Nov 5 2016 [↩]
2. Santander walks away from talks with RBS over Williams & Glyn deal, The Telegraph, Sep 20 2016 [↩]
3. Santander returns with new bid for Williams & Glyn, The Times, Nov 7 2016 [↩] [↩]
4. Darling hails Lloyds and RBS move, BBC News, Nov 3 2009 [↩]
5. Statement on disposal of UK Branch-based Business, RBS Press Releases, Oct 15 2012 [↩]
6. RBS shelves Williams & Glyn IPO, Financial Times, Aug 9 2016 [↩]