The Max Attacks: The RBS ruckus and the government’s nonsensical business sense

Should the government ever get involved in business?

The British government does not have a good track record in commercial endeavours. Its bailout of RBS has to stand as one of the monumental failures of our time. The big question is will the British taxpayers get their money back?

The simple answer is no.

A few facts and figures may help put this in perspective. You’ll appreciate that RBS is a massive and complicated company. Indeed, if you want to find out what they own, fund or invest in, don’t bother looking at their report and accounts. You’d learn more from Peppa Pig. Even so, with the benefit of hindsight, clear warning signals of imminent collapse existed. In October 2007, RBS was part of a consortium that purchased the Dutch bank ABN Amro. Their share cost £10bn. They paid too much.

In April 2008 it was announced that RBS would undertake a rights issue of £12bn. By October 2008 the financial position of the bank and indeed the world had worsened substantially. The British Government took a 58% stake in the group, injecting £37bn into the business. Further investments took place increasing the UK taxpayer interest to 82%. The company remains publically listed as the government’s voting rights are limited to 75% and held through an investment vehicle, UKFI.

Looking at the share price, you may be surprised to see how robust it appears. Latest prices put RBS stock at 330 pence a share. But didn’t they touch just 10 pence a share a little while back? Errm yes, they did. So isn’t Stephen Hester doing a magnificent job? Errm no. Not really (Read my article from last July).

You’re forgetting a rather clever little wheeze. Back in June 2012, RBS shares rose by 960% in one day. Because the company undertook a 10-for-one consolidation. Which just means the shares in circulation have reduced and so the price rose accordingly. At that time the company was worth about £11bn and on today’s prices that has risen to £19bn. Great. RBS is recovering. We’ll get all our money back. Won’t we?

After all, Alistair Darling the then chancellor told us we’d get our money back. In 2008 he said, “There is every reason to be confident that, as we go through this, the British taxpayer will get his money back”. (Perhaps if you view that “she” won’t, that’d be about right!) In 2009 he said “This will provide potential gains in the long-term for the taxpayer”. In 2010 he said we should stick to the plan and turn things around and commented that “I am very confident that will happen”.

But the government put £45.2bn into this behemoth. And that was four years ago. And no one has bothered to look at the cost of capital. Do a few sums and with a rather poor annual expected return of, say, 5%, say, the £45bn invested should now be worth nigh on £55bn. But it isn’t.

And we won’t, ever, get all our money back. Mostly because the bank is pursuing the wrong business strategy. They’ve packaged up many of the good bits and sold them off. For example the IPO of Direct Line, the insurance business, sold into a bad market. The sale of the airline leasing business to Japan’s Sumitomo for £4.7bn back in January 2012 hit objectives of getting rid of non-core business but at what cost? The flogging off of various “non-core” assets has been effective but akin to selling off the family silver.

The bank has written down massive amounts of good loans and sold them off too. They’ve been so mean with what they pay to people who actually do the deals (as opposed to management who seem to be paid very well, thank you. £1.2m a year for a CEO isn’t a bad deal, I’d say) and how they incentivise staff that anyone who was any good has left. They’ve virtually committed the investment banking part of the bank to extinction because of the myopic way in which some view that area of business. Yes, I understand that the word “bonus” is as toxic as Sellafield but that is to miss the point. In order for RBS to return its investment to us, the taxpayer, they have to reinvigorate the parts of the business that will actually make big profits. Big profits don’t magic themselves out of thin air. They certainly aren’t made through retail banking. People with specific skills make big profits. Rightly or wrongly, you have to pay for that kind of talent. Looking at the board, that level of talent is sadly lacking.

Meanwhile they’ve continued to make a total Horlicks of their future strategy.  The “new” RBS we are told is built “on businesses that are customer-centred and highly competitive”. Through sales in what management call their “Non-Core division” they have reduced the bank’s assets by £712bn. So the company is smaller and it’s concentrating on lower margin, lower risk business. Which in turn leads to a lower multiple of earnings for a pricing metric and lower profits.

I don’t entirely blame management either. They have had a tough job to stop the haemorrhaging of money at the bank. However this is a bank that should have failed. It had overreached itself to such an extent with deals and transactions that were never going to pay off, that the balance sheet was shot to pieces. In essence they had turned from a lending institution and advising on transactions to taking principal decisions and principal risk, providing just lending returns. Never a good place to be.

However RBS hasn’t managed to operate without a few fiascos along the way. Back in June 2012, who could forget the computer “glitches” that prevented payments being made to or from bank accounts?  RBS, NatWest and Ulster Bank customers were affected and experienced that “new” RBS “customer-centred” level of service. It didn’t do much for consumer confidence. Nor has the Libor rate-fixing debacle that continued even after the rescue had taken place. Highlighting a significant cultural problem. Oh and a small matter of the £390m fine which has, in effect, been levied on you the taxpayer. Another fly in the ointment is interest rates. You could argue that as and when they rise, RBS will be in better shape. They’ll be able to lend more and receive a higher return. True enough. However the bank still has epic levels of potentially toxic loans on their books. Made safe only by virtue of low interest rates.

In essence RBS has survived because the government guaranteed its losses. Write-downs and asset sales have been used to bolster the balance sheet. The strategy may make a company that on the face of it is profitable. Short of a miracle, with the current strategy, the company will never return its investment to the government. The only people who will benefit will be those who buy the stock when it’s sold off. The lesson from all of this mess is that government should never again be allowed to get involved in business. Like oil and water, they don’t mix.

James Max presents Weekend Breakfast every Saturday and Sunday mornings on London’s Biggest Conversation, LBC 97.3 FM. He is a qualified surveyor and worked in property and finance for 15 years. After working for one of the country’s leading property advisory firms, he completed healthy stints in investment banking and private equity, before becoming a candidate on The Apprentice, which launched a career in broadcast media. Visit JamesMax.co.uk.