RBS May Not Avoid Full Nationalization With Insurance

By Jon Menon

Feb. 25 (Bloomberg) -- Royal Bank of Scotland Group Plc’s effort to put about 200 billion pounds ($288 billion) of toxic assets into a government insurance program may not prevent it from being fully nationalized as the U.K. economy deteriorates.

RBS, the first U.K. lender to take part in the asset protection plan, aims to disclose the terms of its participation when it reports results at 7 a.m. tomorrow in London. Lloyds Banking Group Plc and Barclays Plc may also join the program.

“This is prolonging the inevitable and the inevitable is nationalization,” said Tom Kirchmaier, a corporate governance lecturer at the London School of Economics. “It will instill some trust, but I doubt it will solve all the problems with the banks. We still haven’t seen the worst of the real economy.”

Prime Minister Gordon Brown’s government aims to stimulate lending and jumpstart the economy, which contracted 1.5 percent in the fourth quarter, by insuring banks against losses on assets such as collateralized debt obligations. The government owns 58 percent of RBS and 43 percent of Lloyds after injecting 37 billion pounds into the banks last year.

The insurance plan is designed to reduce the risky assets held by banks and thereby help increase their capital strength, Jonathan Pierce, an analyst at Credit Suisse Group AG in London, said in a Feb. 23 note to investors.

‘Rebuild for Future’

Under a proposal released by Chancellor of the Exchequer Alistair Darling last month, the government will charge a fee to guarantee about 90 percent of a bank’s potential losses on assets such as mortgage-backed securities and consumer loans. Pierce estimates Edinburgh-based RBS will pay as much as 3 percent of the value of the insured assets in the form of non-voting preference shares, with payments spread over three to five years.

“The task for banks is to clean up their balance sheets and rebuild for the future,” Darling wrote in a column in today’s Financial Times. “We need to create the certainty that will enable the banks to lend to creditworthy people and businesses, which is essential of we are to see an economic recovery.”

RBS and Lloyds will pledge to increase lending to homeowners and small businesses by more than 40 billion pounds in return for the insurance, the London-based Telegraph reported, without saying where it got the information.

Deteriorating Economy

RBS may put 200 billion pounds of toxic and non-toxic assets into the insurance program, though the figure is still under negotiation, said a person familiar with the plan who asked not to be identified because the talks are confidential. That could leave the bank liable for another 20 billion pounds of losses. A spokesman for the bank declined to comment.

“There’s a very real risk that equity shareholders end up with nothing,” said Colin Morton, who helps oversee $3 billion at Rensburg Fund Management in Leeds, England. “The economy seems to be deteriorating even faster than we all thought and there are going to be a lot more impairment charges to come.”

Morton said he sold his shares in RBS, Lloyds and Barclays because they were too risky.

Not all investors agree. The insurance plan is probably a “good use of government money” that will lift confidence in the banking system, said Jane Coffey, who helps oversee $63 billion as head of equities at Royal London Asset Management. With RBS responsible for the first 10 percent of losses, the plan may cost taxpayers nothing, she said.

“It will be much easier to generate the recovery going forward,” said Coffey, who owns shares of RBS, Lloyds and Barclays. “We won’t end up having a huge nationalized banking sector.”

Northern Rock

The U.K. nationalized Newcastle-based Northern Rock Plc a year ago, following the country’s first run on a bank in more than a century. In September, it seized Bradford & Bingley Plc after the credit crisis shut off funding.

The government has said it doesn’t intend to nationalize more banks.

“We’ve made it very clear that in our view the commercial sector and private ownership is the right place for banks,” Stephen Timms, chief secretary to the Treasury, told the British Broadcasting Corp. on Feb. 16.

RBS last month forecast a loss of as much as 28 billion pounds, including 20 billion pounds of writedowns on the value of acquisitions such as ABN Amro Holding NV. RBS said it expects to post 8 billion pounds of credit market writedowns for the full year, boosted by losses on U.S. collateralized debt obligations.

Banks worldwide have written down $1.1 trillion and raised $1 trillion in new capital since the credit crisis began, according to data compiled by Bloomberg.

Valuing Assets

The government may not have enough information about the assets it is insuring to know whether the risk has been properly priced, said the LSE’s Kirchmaier.

“The amount of knowledge you need is overwhelming,” he said. “The taxpayer will be the loser in that the pricing will be wrong. I don’t think anyone can value it properly.”

Last month, Lloyds acquired HBOS Plc in a government- brokered deal to head off the collapse of the U.K. mortgage lender. On Feb. 13, Lloyds said HBOS may post a pretax loss of 10 billion pounds. Chief Executive Officer Eric Daniels said he would have taken more time to study HBOS before the takeover if time had permitted.

The government may increase its stake to 70 percent if other shareholders don’t purchase new stock priced at 31.75 pence a share. RBS rose 4.3 percent to 22.1 pence yesterday in London trading.

RBS and Lloyds are already classified as public companies and will add as much as 1.5 trillion pounds to the U.K.’s net debt, an amount equal to gross domestic product, the Office for National Statistics said Feb. 19.

“RBS and Lloyds are tumbling toward full nationalization,” said Simon Willis, an analyst at NCB Stockbrokers Ltd. in London.

To contact the reporter on this story: Jon Menon in London at jmenon1@bloomberg.net