Royal Bank of Scotland, 70% owned by the British Government, announced its 2009 first quarter results on 8 May to varying reaction. The BBC’s Robert Peston saw the announcement as evidence that the banking sector was starting to recover. The FT’s headline, however, was rather more downbeat: Impairments at RBS soar to £3bn. RBS’s CEO himself said he saw no green shoots, even though the bank’s reported loss before tax was ‘only’ £44m. Notably, the Global Banking and Markets division (‘GBM’, the investment bank segment), increased its top-line revenues as against the same quarter in 2008 by £2bn to £9bn and reported an operating profit (more on this below) of £2bn.
The interim management statement provides clues to the deeper story, although as always with financial statements, it is often hard to see what really happened. In particular, the increase in GBM revenues in the downward run of a recession seems strange.
RBS reported impairments - losses on regular business, for example, defaults from corporate or personal borrowers - of £2.8bn for the quarter. RBS’s CEO expects this charge to be repeated in each further quarter this year, so potentially reaching £11-12bn, compared with £7.4bn for the whole of 2008. This level should not, given the recession’s likely progress, be surprising.
RBS states further that they expect 75-85% of these impairments to count towards the first loss (retained) tranche under the UK government’s asset protection scheme. The bank’s participation in this scheme is still being negotiated and will need the approval of its non-government shareholders. It is not normal for an insurer to allow losses incurred before a policy starts to use up the policy excess (think about trying that on with your motor insurer), but this appears to be what RBS expects. There is, however, insufficient information here to judge whether the cost to the government of these pre-policy-losses is to be recovered somewhere else.
On top of impairments, credit market write downs were stated as £797m. These are mostly re-valuations of credit market instruments held by the bank. GBM’s contribution to this number was £2bn. Set against it was a positive adjustment for the ‘fair value of own debt’ over £1bn. The bank takes a profit of £1bn for the fact that its debt – bonds issued to raise capital – were it to redeem it, is worth £1bn less than it was 3 months earlier. That’s the good news, then.
What is GBM’s business and what was it doing to increase revenue? It’s not entirely clear from the report. Most of GBM appears to be derivatives trading. The report states that it “delivered a strong income performance across all business lines in the first quarter of 2009, most notably in rates, currencies and credit markets.” The rates segment “benefited from increased market volatility (!) and strong customer demand,” the currencies business revenues increased by a third, and the credit markets business “benefited from a more stable trading environment helped by various US Government schemes driving increased activity particularly in the US mortgage trading business.”
Reading between these lines, it seems likely that GBM’s £2bn revenue increase represents: (a) continued position taking in the derivatives markets (as evidenced by the fact that they have nearly £900bn of gross derivatives balances on their balance sheet, only £100bn less than a year ago); and (b) the opportunities for profitable trading, possibly arbitrage, arising out of government support for asset markets – indeed who is better placed than the banks themselves to trade in an environment dominated by concerns over the banks’ viability and government policy towards them? It is also notable that the operating profit of GBM is cancelled out by the credit market write downs attributed to it. If you add to that some ‘impairment reclassifications’ relating to GBM, it appears that the derivatives trading division’s name is on pre-tax losses of around £750m for the quarter and that only £1bn of own-debt revaluation enabled this to be brought back to the headlined £44m group loss.
When he announced the RBS bail-out, the British Prime Minister grandly said, “We must now put in place new structures and new rules for the future. This cannot simply be a short-term rescue to paper over the cracks. Only a surgical approach that gets to the root of the problem will now work to ensure the problems do not return.” Much was made of the return to sound commercial and retail banking. The recession will mean, of course, that those activities will be stressed for some time to come. But it does not mean that taxpayers should subsidise trading in derivatives - whether explicitly through bail-out money or implicitly through trading opportunities presented by state action to support specific institutions, asset classes or the wider economy.
It seems politics have left RBS behind and that we’ll shortly be back to business as normal. This is entirely consistent with a politics that believes that providing money without providing direction or taking responsibility is all that is required for a public service - which, after all, RBS now is.