Bang to rights

16 Sep 2016 By Liam Proud

Royal Bank of Scotland’s return to dividend-paying ways depends on it avoiding a double dose of bad luck. The UK lender’s two largest outstanding bits of litigation consist of allegations it mis-sold U.S. mortgage securities and a shareholder suit related to a 12-billion-pound rights issue in 2008. Two charges at the top end of expectations would blow a hole in its capital. That probability looks remote – though rival Deutsche Bank’s ongoing tussle with U.S. regulators raises the stakes.

The prospect of RBS being whacked for the fullest possible amount seems most unlikely when it comes to the lawsuit over its 2008 cash call prospectus. Because damages and legal costs could be borne by RBS, claimants who are still shareholders would also smart. They might thus choose to settle for less than the maximum 6 billion pounds sought, even if a London court concludes the bank failed to make adequate disclosures just months before its government rescue.

U.S. fines could be punishing. RBS has provisioned about 4 billion pounds for penalties for alleged mis-selling of mortgage securities. But it has yet to reserve any money for a Department of Justice (DOJ) fine. The Federal Housing Finance Agency has suggested in court filings that it and the DOJ may seek up to $13 billion (9.8 billion pounds) in total from RBS, which provides an upper estimate. Deutsche Bank on Sept. 15 sought to downplay the chances of it paying $14 billion to settle a similar set of cases.

If both cases did turn out for the worst, RBS’ common equity Tier 1 capital as a proportion of its risk-weighted assets might slump to as low as around 10 percent, on Breakingviews’ calculations. That’s not terminal. But with the Bank of England’s rough requirement for the industry at around 13 percent, RBS wouldn’t be able to return capital to shareholders for some time.

Assume a better outcome instead. Some analysts peg a possible DOJ fine at around 2 billion pounds. Meanwhile, the investors suing RBS might in fact extract little more than 2.5 billion pounds: they are yet to agree on how to value the damages, and the floated 4 billion pound figure assumes they will be compensated for the full value of their shares, not actual losses. Given charges along those lines, RBS would just maintain a 13 percent capital ratio. There would be no excess capital to give back to investors. But at least RBS would still be able to contemplate the possibility.


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