RBS’s Decision To Scrap Williams & Glyn Sale Is A Good Thing For The Bank In The Long Run

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

Late last week, The Royal Bank of Scotland Group (NYSE:RBS) announced that it will no longer pursue a sale of its Williams & Glyn unit and will instead restructure the operations to help promote competition in U.K.’s SME (small and medium enterprises) banking sector. [1] RBS, which is 72% owned by the British government, worked with the U.K.’s Treasury to come up with the new plan, but will have to wait for the European Commission’s (EC) approval to implement this change. If the EC approves the new plan, then RBS can put to rest the nagging issue of resolving the fate of Williams & Glyn – a unit the bank has been unsuccessfully trying to dispose of since 2010. This will finally pave the way for the bank to reinstate dividend payouts.

The proposed plan comes with its own set of issues, though, as it will force RBS to incur sizable expenses in terms of restructuring costs as well as perks and incentives to small banks in the future. The bank has already announced a £750-million ($935 million) hit to its results for Q4 and FY 2016 as it provisions for the expected cost of implementing the new plan. Despite this, we believe that RBS stands to gain from retaining Williams & Glyn. This is because the unit is very profitable – generating almost 12% of RBS’s total adjusted pre-tax profits for the first nine months of 2016. Moreover, a potential sale of the unit would have gone through at a steep discount to its intrinsic value – so RBS is actually gaining by just retaining the unit. Our belief is further supported by the fact that the £2 billion RBS has spent upgrading and restructuring the unit over recent years will allow it to function independently of the bank’s other operations. This keeps the option of a sale alive in the long run, when improved market conditions should help the bank fetch a better value for Williams & Glyn.

Investors clearly saw the scrapped sale as a positive for RBS, as the bank’s shares increased 7% in response to the news. We are currently in the process of updating our $6 price estimate for RBS’s stock, which is now slightly below the current market price.

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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. [2] 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 a troublesome affair for the bank.

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. [3] 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, even as the EC extended the deadline to the end of 2017. However, plans for a spin-off had to be abandoned last August, as continuing technology issues and poor equity market conditions in the wake of the Brexit vote made separating Williams & Glyn an untenable proposal. [4] At this time, RBS reinitiated talks with potential buyers for Williams & Glyn – including Santander and Clydesdale & Yorkshire Bank (CYBG). But a deal did not materialize because of low bid values, as well as the possibility of significant regulatory scrutiny of a deal with Clydesdale given the latter’s ongoing struggle to maintain profitability.

RBS announced late last year that none of its existing proposals could deliver a complete divestment of Williams & Glyn by the end of 2017, and then began working with the government to come up with an alternative option that would be acceptable to the bank, the British government as well as the EC. The recently announced plan seems to be the best path forward for all involved. In a nutshell, the rejigged plan will let RBS to retain Williams & Glyn as a separate unit that will focus completely on aiding smaller banks in the U.K. that lend to SMEs. The smaller banks can leverage the unit’s financial and technological strength to improve their services and reach – something that should help revive the country’s frail SME lending sector. The plan is expected to be investigated by the EC over the next two months and is very likely to be accepted. [5]

RBS reports results for Williams & Glyn as a part of its non-core operations. While the announced provisions of £750 million for 2016 linked to the deal will hurt margins for the year – with more such one-time charges very likely in the short run – we expect margins to improve considerably in the future. The impact of changes in RBS’s non-core operating margin on our price estimate for the bank can be understood by modifying the chart below.

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Notes:
  1. Update on RBS’s remaining State Aid obligation, RBS Press Releases, Feb 17 2017 []
  2. Darling hails Lloyds and RBS move, BBC News, Nov 3 2009 []
  3. Statement on disposal of UK Branch-based Business, RBS Press Releases, Oct 15 2012 []
  4. RBS shelves Williams & Glyn IPO, Financial Times, Aug 9 2016 []
  5. RBS close to being spared Williams & Glyn sale, Financial Times, Feb 20 2017 []