How Do You Exit a Bailed-Out Bank? Carefully

(Bloomberg) -- Only in the world of finance does a $4.9 billion fine look like good news. Royal Bank of Scotland Group Plc's settlement with the U.S. Department of Justice over its role in the sale of toxic mortgage debt triggered a jump in the lender's shares and raised expectations of juicy dividends to come.

Crucially, the deal paves the way for a sale of the government's 70 percent stake, currently worth about 24 billion pounds ($33 billion).

This will need to be handled carefully: at 45.5 billion pounds, RBS was the costliest bank bailout of the financial crisis for taxpayers. After a decade of losses, RBS's stock is still below the price at which the government would break even on its investment. 

A quick banner stock sale like those of ABN Amro or Allied Irish Banks Plc looks unlikely. The government’s approach of selling its stake gradually over several years, similar to how it cut its 43 percent stake in Lloyds Banking Group Plc, looks more sensible.

RBS will be a tougher sell than Lloyds. The state's stake is far bigger, and the lender's restructuring has been deeper and more painful. Today, the two banks' balance sheets are roughly similar in size. A decade ago, RBS's assets were twice as big. Even after the U.S. settlement, the lender will be vulnerable to the threat of Brexit, a slowing economy, rising loan loss provisions and intense competition in mortgages.

A one-off privatization that crystallizes a loss for the government risks public anger: if the shares rise afterwards, the taxpayer misses out on the gain; if they fall, individual investors get hit. Look at how the government was criticized for privatizing Royal Mail Group Plc after the stock surged after its initial public offering. The risk with RBS would be an order of magnitude bigger. Better to go slow.

With about 12 million shares trading daily on average, it would in theory take the best part of two years to sell the government's RBS stake into the market. In practice, it would take longer.

RBS could make the process easier by buying back shares as part of the process, according to Jefferies analyst Joseph Dickerson. It would be a similar step to one taken by bailed-out U.S. insurer AIG in 2012. If the government were to sell a block of about 3.5 billion pounds of stock, or 10 percent of the bank, RBS could buy half of it, or 5 percent. That would offer the added mechanical lift to earnings-per-share that buybacks deliver by reducing the bank's share count.

This week's settlement may be viewed as the turning point for RBS. The bank has built up capital buffers, cut costs, shrunk its investment bank and can finally resume dividends. But it would be hard for taxpayers to call any of this a happy ending. A careful sell-down would, though, be the least unhappy of all.

©2018 Bloomberg L.P.

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