UK banks: Nine months is a long time in UK banking. When Royal Bank of Scotland and Lloyds Banking Group signed up for state insurance on a combined £585 billion of their suspect loans in February, each was assumed to be a basket case. Now the full details of the insurance scheme and enforced state aid disposals are public, it's clear that RBS is in the worse shape. Both banks are trying to wriggle out of the state’s embrace, but RBS hasn’t got very far. Lloyds, in contrast, is well on the way to independence.
RBS has managed to cut its reliance on the government’s asset protection scheme. It is buying insurance on £280 billion of bad assets rather than £325 billion. It will also absorb the first £38.7 billion of losses on these loans – double the original idea. All this means that it doesn’t have to pay an upfront fee of around £17 billion.
Unfortunately, there are no free lunches. In order to withstand the extra risk that RBS is taking onto its own balance sheet, it will have to raise more capital. And there is only one buyer: the state. RBS will issue it with £25.5 billion of non-voting B-shares.
And because the authorities don’t think even that’s bullet proof, the government has promised to inject a further £8 billion if its core Tier 1 falls below 5 per cent. That will cost it £320 million a year. What’s more, the government’s stake, already 70 per cent, will rise to 84 per cent — and even more if the £8 billion is called upon.
Lloyds, by contrast, sidesteps state insurance entirely. It, too, needs to strengthen its balance sheet. But it is largely tapping the market, rather than the government, to achieve this. £13.5 billion will come via a rights issue, to which the state will contribute. Another £7.5 billion in core Tier 1 capital will come by swapping hybrid bonds into a new instrument that automatically converts into equity if Lloyds’ core Tier 1 ratio falls below 5 per cent.
Under the original plan, the government’s stake in Lloyds was slated to rise from 43 per cent to 60 per cent. Under the new one, it could even fall – if the new £7.5 billion instruments convert to equity. Moreover, the bank is only paying an extra £90 million a year to the hybrid holders to get its contingent capital — less than a third of what RBS is paying the government.
The long-term implications are also strikingly different. Lloyds’ core Tier 1 ratio rises to just over 8.6 per cent, excluding the contingent capital. That suggests the Financial Services Authority believes Lloyds’ assertion that impairments have peaked.
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RBS, by contrast, will have a core Tier 1 ratio of 12.5 per cent without the contingent capital. When you add in the fact that it has access to the asset protection scheme, it looks like the regulator thinks belts and braces are still very much needed.
The coup de grace is Brussels. The European Commission will force RBS to sell its insurance arm and its commodities trading arm on top of reducing its small business lending by five percentage points. That may not hurt shareholders, as it has four years to dispose of the assets. But because Lloyds will take no further state aid, it can simply sell what it wanted to sell anyway – and still hold dominant 25 per cent market shares in personal current accounts and mortgages.
It may not be long before Lloyds resembles a normal bank. But RBS could well be a ward of the state for years to come.
