Retreating from the United States looks the least-bad option for Royal Bank of Scotland. Regulators want the U.K. lender to bump up its capital ratios, and they've identified a disposal of U.S. commercial bank Citizens as the obvious method. A quick sale has big drawbacks. But so does doing nothing.
True, there are good reasons not to sell Citizens now. In the first nine months of the year, the U.S. commercial bank generated over 9 per cent of group pre-provision profit. RBS is still making an overall loss, and if the U.K. government wants to start selling down its 81 per cent stake in 2014, it needs a profit in order to pay a dividend.
A sale now would also generate less capital than a sale later. Citizens might fetch 1.1 to 1.5 times its tangible book value, according to Mediobanca research. A deal would probably happen at the bottom end of this range, given that Citizens' returns look below its cost of equity. That might generate 150 basis points of core Tier 1 capital, against 200 bps if RBS waited for things to improve and achieved 1.5 times, Mediobanca reckons.
The bigger snag is that RBS's capital position, like most of its peers, is weaker than it looks. Incorporating tougher Basel III capital rules pushes the core Tier 1 ratio down to roughly 7.5 per cent, based on the bank's most recent guidance. RBS does reckon it can get back up to 9-9.5 per cent by the end of 2013. But that depends on successfully mitigating the effects of risk-weighted asset inflation under Basel III, and a big, systemically important universal bank like RBS probably needs 10 per cent.
Third-quarter results suggest RBS will struggle to generate a net profit for the time being. Although the final leg of the bank's £258-billion ($412-billion) of non-core asset deleveraging will increase capital by slashing RWAs, the U.K. economy is unlikely to motor sufficiently for RBS to start generating lots of capital. Mortgage insurance mis-selling and potential Libor litigation charges also weigh.
RBS is caught between two political imperatives: a sell-down of the government's stake, and the removal of questions about its capital. The capital issue is more pressing.