Rebuilding RBS

Wednesday 27th May 2009

The pleasant, slightly pudgy baby face of Stephen Hester, the new boss of Royal Bank of Scotland (RBS), is deceptive. Hester has to brutally axe thousands of jobs – possibly more than 20,000 – across the entire bank network as RBS retrenches across the globe, undoing deals from their retail and commercial banking operations in an effort to slash costs. The new CEO of RBS, which is now majority owned by the British tax payer, is effectively reversing the aggressive global acquisition strategy of former boss Sir Fred Goodwin, still smarting from his publicly shaming decision to keep his £700,000 for life pension after running RBS into near oblivion. Hester also has to perform his new role in the full glare of an unmerciful media who will be pounce at the slightest gaff or whiff that the public – still outraged about the level of some City bonuses – are not getting value for money.

So, what sort of man would want to take on such a challenge, especially when the bank recently announced losses of more that £24bn, the biggest loss in British corporate history? More to the point, who is Stephen Hester?

Physically big – Hester has successfully trimmed his boxer’s build by two stone recently – he’s naturally intellectually confident and his grasp of detail is huge. Born in 1960, the son of an Oxford University don, he went to Oxford University, leaving with a first class degree in politics, philosophy and economics. He is a man known for a cool, analytical mind; he’s also known for his forensic knowledge of the banking sector from both sides – lender and borrower. Although his last post at British Land was essentially a property business, it also had many banking clients. Hester originally climbed the financial corporate ladder rapidly, becoming Chief Financial Officer at Credit Suisse First Boston by the time he was 35. A stint at Abbey National (as it was then known) as financial director followed where he successfully sorted out a load of toxic debt, before flogging the bank for £9bn to Spanish Bank, Banco Santander.

Hester the action man
What he is widely admired for – which no doubt will comfort the Government and other investors – is that he has a strong track record of clarity and action in times of trouble. Clarity is linked to confidence, something the City needs. He promptly issued a profits warning when he moved to Abbey with badly needed restructuring following. His last job at property investment company British Land was a tenure widely admired for its prudence, selling off almost £6bn worth of older property and reducing debt levels; and unlike many other property companies, British Land remains on a sound financial footing. Although John Ritblat, his British Land predecessor, was a hugely forceful personality, openness was not one of Ritblat’s strengths. Hester, in comparison, offers a lower key, softly spoken approach, a style in keeping with the downbeat recessionary times. He certainly broke new ground at British Land by introducing quarterly reporting – a boon for investors – and flipped homes, dumping British Land’s traditional historic Regent’s Park pile for a more modern, anonymous building that was considerably cheaper to run.

But the new boss of RBS, a fabulously wealthy man by any standard thanks to his many years in investment banking, will need to muster all his communication, intellectual and leadership skills to turn RBS around. He is denied the luxury of being able to re-structure the troubled operation privately; he has to perform the job not only in the glare of the media, but also in front of government and disgruntled shareholders – a constantly swiveling audience, all demanding communication in their own language. The government certainly has their own politically driven agenda, obviously, which want to see much more restrained bonus payments, responsible lending and possible probes into the behaviour of former colleagues. “It’s an absolutely grim scenario,” says Justin Urquhart Stewart of financial advisers Seven Investment Management. “Ideally, the best idea in this situation would be to suspend RBS shares for two years which would allow Hester to perform the nasty surgery in a dark room privately. This situation needs to be done quietly, in the old fashioned way: send out the lifeboat. RBS now is effectively a zombie bank and even with the support of the government, it’s a terrible situation.”

Regular TV and radio appearances will take up time for Hester, but they have to be done, given the amount of explaining needed. The latest round of explaining will be about certain ‘unconventional aspects’ of Hester’s own pay deal with RBS, which the Association of British Insurers has flagged up (Hester has no performance targets attached to his share compensation package). The FSA is also about to launch an inquiry into allegations that RBS non-exec directors were intimidated by RBS’ boardroom culture, largely shaped by Sir Fred Goodwin. Such transparency will help his own employees. Goodwin was often, some employees have said, difficult to predict, which took its toll when it came to second-guessing his decisions.

The actual scale of the reversal has also to be fully grasped. Hester himself has already said a full retreat could take five years, though of course it could be even longer. The British banking system is also not known for its appetite for wholesale change, despite it containing many clever people adept at creating risk models and types of securitisation that few people, as it turned out, really grasped properly.

Too many cooks?
Given the sacks of taxpayers' cash propping RBS up, Hester will have to deal with civil servants and ministers on a daily basis, which will demand large reserves of diplomacy. The British civil service is a very different animal to the banking and investment world. Meanwhile, more than £800m has to be pumped into various staff and exec pension schemes after RBS’ pension funds revealed a deficit of £2bn in the last year, which also includes the £703,000 pay-out scheme to Sir Fred Goodwin. This is blamed on the state of retreating investment markets worldwide. Shares in RBS meanwhile have lost more than 94 percent of their value. Investors continue to chew over whether it’s time to buy back into banking shares given their astounding valuations, or to swerve completely given the general lack of visibility and anxiety that some shares could be little more than worthless. Then there’s always the lurking threat that RBS could be completely nationalised. Hester, 48, has already warned that more credit losses could mount, and that on-going extra taxpayer support could be needed during the next five years. Much of his staff – some of them labelled with failure and public-shareholder contempt – meanwhile are themselves at rock bottom. In other words, Hester has to clear up chaos. “Basically, there’s too many cooks, all pulling in different directions,” said one City analyst. “Having said that, Ron Sandler at Northern Rock seems to be getting on with things behind the scenes. However, you don’t tend to read in the media about what Northern Rock may be up to next. Hester has less leeway.”

Selling up
Hester claims so far that the key building blocks for RBS’ recovery are more or less in place. It is likely RBS will bail out, or significantly prune back, in more than 30 of the 54 countries it’s currently tied to. That alone will be quite a challenge as many buyers are likely to be few on the ground given current economic conditions, however, businesses in places like India and Taiwan are likely to be picked up quickly thanks to Asia’s higher rate of growth generally.

And there’s a lot to pick up. RBS’ disastrous ABN AMRO acquisition in 2007 handed RBS significant sub-continent assets, including around 3.7 million Indian retail customers, for example, and around 30 branches. RBS is heavily represented in Indonesia too with around 20 branches spread between 10 cities, though likely buyers could even include antipodeans such as ANZ Bank.

However, buyers for a range of assets are thin on the ground. Anywhere where far-flung RBS lacks a large-scale presence they will likely quit. US-based Citizens Financial Group, owned by RBS, is likely to escape a sell-off, but it too is in lacklustre health (it posted more than $900m in losses last year thanks to a huge $1.5bn write-down). Citizens’ own Midwest banking franchise Charter One has had plenty of exposure to the turmoil in the US’ troubled auto industry.

However, RBS’ insurance arm, Direct Line, is an excellent business for the most part, and in ordinary times, finding a buyer for it would not be too much of a problem. But these aren’t ordinary times. The insurance industry is now increasingly vulnerable to the economic contagion and it could be a while – even years – before the poison lurking in some of its assets is fully sucked out. City expert Jon Horton from Chamberlain de Broe financial advisers reckons the insurance industry is almost certainly likely to the next on the casualty list. “Clearly no one has chewed their [RBS] arm off for it yet. Certainly, the insurance industry is ripe for a capital crisis, though we haven’t seen any big insurance players submit any rights issues yet, but that could be further down the line. But when you have a weak parent, that’s a whole heap of trouble.”

Another City expert says Hester, very simply, has to focus on the good parts of the business, rather than wasting energy and time righting the bad. “I’d urge him to concentrate on building a smaller, well-formed business that’s capable of lending more, then grow it back from there. There are examples of where this has been done before; Lloyds of London 15 years ago was in a similar situation; it was absolutely bludgeoned. They needed time and the privacy to re-build – and they did.”

Hester certainly has plenty of incentive to make sure a recovery is a sure-fire bet. When he arrived at RBS, he was handed £10.4m RBS shares at a time when they were worth 65 pence. Before going to press, these shares were worth nearer 20 pence. That’s a paper loss of well in excess of £4m. And if RBS is nationalised, then he’s going to lose it all.

Not quite a corpse case – yet
So the task in front of him is truly huge. He has to turn RBS almost full circle back to its basic core services of retail and commercial banking, well away from the complex and perilous shifting sands of investment banking.

Some meanwhile wonder just how fair a deal the British taxpayer is getting in return for the bail out (some reckon the public now actually own 95 percent of the bank). Meanwhile, the government is to hand RBS at least £19bn in state aid (though in the form of non-voting preference shares) while taking back £6.5bn in RBS (non voting) shares. The point for the government though is that RBS cannot be allowed to fail – it’s simply too big. Of course, there’s always the hope that if Hester can pull it off, the taxpayer would be in for a substantial profit once the shares are flogged back to the market. But that’s a huge If.

Willem Buiter Maverecon, professor of European political economy and former external member of the British MPC wrote in the FT recently that he thought the taxpayer was being ripped off. “The Treasury’s deal with RBS under the Asset Protection Scheme is even more disadvantageous to the tax payer than I had feared. The government will insure £325bn of RBS toxic assets, with a first loss for RBS of only six percent (£19.5bn), and with RBS taking only 10 percent of any loss in excess of the first loss limit. The fee paid by RBS is just two percent of the amount insured (£6.5bn), much lower than the market (and I) had anticipated, and it is paid in RBS B shares. This means that if and when RBS goes bust, an event that is not altogether unlikely, the cumulative value of the insurance fees already paid to the government will be zero.” Maverecon then went on to describe RBS as a dead bank. “It isn’t even a dead bank walking any longer – more a dead bank stumbling and fumbling around.”

Nevertheless, not everyone thinks that RBS is a complete corpse case. Vanessa Rossi at Chatham House, the Royal Institute of International Affairs, thinks it has a chance. “If he’s [Hester] clever, he’ll make it work. He’s got some pretty brutal restructuring to do, a job that’s never easy. What he absolutely must do is make sure that he makes the right decision first time around, then he’s got to work like crazy to convince everyone that he is right and that it’s a viable model. You can’t have repeated tries at it. He may actually find it’s actually easier to drive through difficult decisions with government backing. But that means he has to work with the government, not against them.”

Hester will certainly need his sense of humour in the meantime. He is known to have a dry, acerbic wit. And there are private consolations. He has a 350-acre estate in rural Oxfordshire where he indulges his love for hunting, gardening and tennis, plus there’s a Swiss ski chalet to retreat to. But his burden is truly colossal. He recently admitted to Evening Standard journalist Chris Blackhurst “there’s a shitload to do.” Indeed.


The RBS ‘self-help’ diet in detail – how Hester will trim down

20,000 jobs are likely to go.

Global banking assets likely to be sold off or severely shrunk.

Utilise the government’s asset protection scheme to help restore RBS to health.

Not all non-core assets are poor performers, like the RBS-owned insurance company Direct Line. However, finding a buyer at a fair price could be challenging in the current climate.

Running cost savings should save the bank around £2.5bn a year.


Stephen Hester CV

Born: 14 December 1960.

Spouse: Barbara Abt.

Children: 2.

Education: Easingwold School in North Yorkshire, Oxford University.

Career:  Credit Suisse (1982 – 2002), Abbey National (2002 – 2004), British Land (2004 – 2008), Northern Rock (2008), Royal Bank of Scotland (2008 – Present).

Famous Quote: “I don’t believe we’re about to see a market decline, but the period of sharp growth is over. Now we go into a period of steady but lower growth, so it will be more visible when you make mistakes.”


RBS in numbers

700 branches of RBS, mainly in Scotland.

£24.1bn – the loss RBS recorded in 2008.

170,000 employees in 2008.

1727 – The year in which RBS was founded.

8 sectors that  RBS is split into: Retail banking, wealth management, retail – direct channels, corporate markets, RBS insurance, Ulster Bank Group, citizens and manufacturing.

57 -  the bank’s equity share capital owned by the Government.

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