By Ian Fraser
Published: Sunday Herald
Date: 3 November 2013
It will not be broken up … but the future is far from plain sailing. By Ian Fraser
Ross McEwan had a baptism of fire on Friday when he made his first set-piece announcement as chief executive of Royal Bank of Scotland. There were a few shreds of good news, including that the Treasury has decided against breaking up RBS into a “bad bank” and a “good bank”, and the fact that RBS had managed to lift its core tier-1 capital ratio – a measure of financial strength – to 11.6% from 9.1%. Rather than breaking up RBS, the Treasury decided the Edinburgh-based institution in which it owns an 81% stake is to create an “internal bad bank” – essentially a re-brand of its existing “non-core” division – to house £38 billion of toxic loans, and that these have been earmarked for accelerated run-off over the next two years.
Much of the rest of Friday’s announcement was negative. McEwan – who ran RBS’s retail banking arm for a year before becoming its chief executive – said the new internal bad bank meant RBS would have to take some £4.5bn in impairment charges in the fourth quarter of 2013, implying a full-year loss. He also said that RBS had made a loss of £634 million in the third quarter. And an independent review into the bank’s small business lending led by Sir Andrew Large confirmed what was widely suspected: that the bank’s approach to small business lending is dysfunctional, and that it must do better. What was not so obvious from Friday’s string of announcements, however, was that a number of enormous landmines continue to lurk just under the surface of the bank’s Fred Goodwin-ordered blue-and-amber carpets. Here is a selection of these unexploded bombs – the litigation risks and legacy issues that McEwan still needs to try and defuse.
UK: PPI mis-selling – Estimated liability: £2.65 billion
RBS has set aside £2.65 billion in provisions to cover the cost of compensating customers to whom it mis-sold payment protection insurance (PPI). This often redundant product was highly lucrative for the banks but was useless to many of the people who bought it. The bank now has 1,800 staff working full-time on PPI redress. It threw an additional £250 million into the compensation pot on Friday.
UK: Rights issue class action – Liability: up to £13 billion
The bank is fighting the UK’s largest ever class action case in the High Court. The suit comes from 13,000 RBS investors who allege that the bank duped them into putting £12.3 billion into a rights issue in April 2008. On 30 July, the RBoS Shareholders Action Group was ordered to amalgamate its £4.3 billion claim with those of two other investor groups. A QC’s opinion last year found that asset-management firms that bought into the rights issues that fail to participate in the action could risk being sued by investors. The bank said: “RBS considers its has substantial and credible legal and factual defences to these claims.”
UK: Card and identity protection insurance – Estimated liability: £200 million (based on RBS’s market share)
The bank misled customers into buying insurance for their credit cards and identity theft insurance from London-based Card Protection Plan. On 22 August, the FCA declared that CPP and RBS, alongside 12 other banks and credit card issuers, had agreed to a £1.3 billion compensation scheme.
UK and Ireland: IT meltdown – Estimated liability: up to £300 million
On 19 June 2012, RBS suffered one of the worst IT meltdowns in banking history, with millions of customers locked out of their accounts for days and customer transactions going awry. The bank has promised to reimburse customers for any losses they suffered and paid out £175 million in 2012. The incident is also the subject of regulatory inquiries in both the UK and Ireland, and RBS may also face claims for damages through the courts.
UK: “Systemic abuse” in restructuring and recovery – Estimated liability: up to £5 billion
Allegations of “systemic institutionalised fraud” in RBS’s recovery and restructuring division (West Register and Global Restructuring Group) are being investigated by a number of civil and criminal UK authorities. Lawrence Tomlinson, chairman of Leeds-based LNT Group and entrepreneur-in-residence at the Department for Business Innovation and Skills, alleges: “This is a massive scandal. It’s about the bank creating situations that put people into a corner where it can hit them with outrageous fees and transformed into zombie companies.” He is providing 300-400 case studies to business secretary Vince Cable.
UK: Interest rate swaps mis-selling – Liability: up to £1.5 billion (if FCA fines RBS)
In February, RBS booked a £750 million provision to cover compensation for small businesses to which it mis-sold interest-rated hedging products, a figure that experts believe may be too low. After initially denying it had done anything wrong, the bank now says it will provide “fair and reasonable redress” to eligible customers under a redress scheme agreed with the FCA. Speaking on the BBC’s Panorama last month, FCA chief executive Martin Wheatley warned the regulator may also fine banks involved in the scandal.
EU: Credit default swaps anti-competitive behaviour – Estimated liability: unknown
EU cartel-busters are investigating RBS’s role in the credit default swap (CDS) market and handed the bank a statement of objections in July. The EC has raised concerns that a number of banks, plus data provider Markit and industry group the International Swaps and Derivatives Association may have jointly blocked exchanges from entering the CDS market. RBS said: “At this stage, the RBS group cannot estimate reliably what effect the outcome of the investigation may have on the group, which may be material.”
Singapore: Benchmark rigging – Estimated liability: £500 million-£600 million
RBS was one of 20 banks penalised by the Monetary Authority of Singapore in June for rigging Sibor (the Singapore Interbank Offered Rate) and other benchmarks between 2007 and 2011. RBS has set aside additional statutory reserves with MAS of Singapore $1 billion-$1.2bn (£500 million-£600m) and has been forced to improve its systems and controls in Singapore.
US: SEC “Wells” notice for defective residential mortgage-backed securities – Estimated liability: unknown
The US Securities and Exchange Commission slapped a “Wells” notice on RBS on 28 March, giving notice of its intention to sue. The suit relates to allegedly faulty mortgage-backed securities dating from 2007. The SEC started its probe in September 2010, when it asked RBS for information concerning residential mortgage-backed securities underwritten by US subsidiaries of RBS in the period September 2006 to July 2007.
US: Defective mortgage bond issuance – Estimated liability: $4 billion-$6 billion
RBS, through Greenwich Capital, sold $32 billion of allegedly defective mortgage-backed securities to American state-owned mortgage giants Fannie Mae and Freddie Mac. Now the Federal Housing Finance Agency (FHFA) is suing RBS over these the bonds. The FHFA alleges that RBS routinely breached mortgage-lending rules and bullied surveyors into inflating property valuations. Overall, RBS is being sued for $91bn of mortgage-backed securities and has been named as defendant in 45 lawsuits related to mortgage-backed securities.
US: Weak anti-money-laundering controls – Estimated liability: up to $1.5 billion
On 27 July 2011, RBS was hit with a cease-and-desist order by the US Federal Reserve over violations of money-laundering laws. This required RBS to improve risk management and compliance to ensure does not get used as “washing machine” for the laundering of funds for countries subject to US economic blockade, such as Iran. RBS is “continuing to co-operate” with inquiries led by the Department of Justice and has “conducted disciplinary proceedings against a number of employees”.
US: Mortgages – loan repurchases and indemnities – Estimated liabilities: $750 million
When bundling mortgages into mortgage-backed securities, the bank’s M&IB arm (formerly GBM) and Citizens asked issuers of the underlying mortgages to provide certain warranties. In instances where issuers refused, M&IB tended to issue the “representations and warranties” itself. In such cases, the bank is liable to repurchase the bonds or else “indemnify certain parties against losses”. Between early 2009 and June 2013, RBS received $741 million in repurchase demands, which it is striving to resist. The bank said: “The volume of repurchase demands is increasing and is expected to continue to increase.”
US: Credit default swaps anti-competitive behaviour – Estimated liability: unknown
In May and August 2013, RBS and other banks were sued in anti-trust class action suits filed in courts in Illinois and New York state. The complaints allege that RBS broke competition law in the market for credit default swaps, driving up bid-offer spreads. The bank admits the cases could lead to “investigatory or other action being taken by governmental and regulatory authorities” and could have a “material adverse effect” on RBS group.
US: Other allegedly faulty securitisations – Estimated liability: unknown
In January 2011, the SEC launched a formal inquiry into inadequate documentation relating to RBS’s US mortgage securitisations. This followed subpoenas in 2007 of several players in the US securitisation industry, focusing on information underwriters obtained from independent firms that performed due diligence on underlying loans. RBS gave relevant documentation to the New York attorney general in 2008. RBS said: “The investigation is ongoing and the RBS Group continues to provide the requested information.”
Global: Libor – Estimated liability: RBS already fined £390 million; the ultimate cost could be as high as £80 billion
On 6 February, the US Department of Justice and the Commodity Futures Trading Commission (CFTC) and the UK’s Financial Services Authority fined RBS $612m (£390m) fine for rigging Libor, the benchmark interbank interest rate. Other banks and brokers penalised for similar offences include Barclays, UBS and Rabobank. RBS faces further penalties from the EU and Canadian Competition Bureau, plus civil claims from US investors, the most recent of which came from mortgage giant Fannie Mae last Thursday. Analyst Sandy Chen has said if there was just 0.05% mispricing in interbank rates over four years – less than the 0.4% some class action lawsuits allege – RBS faces possible damages of £80bn.
Global: ISDAfix – Estimated liability: unknown
Multiple agencies and regulators around the world are investigating RBS for possible rigging of IDSAfix, a benchmark used in the interest rate swaps market. America’s CFTC is examining about one million emails and phone call recordings related to the alleged manipulation, involving traders from RBS and more than ten other global banks and brokerages.
Global: FX market rigging – Estimated liability: unknown
On Thursday it emerged that two of RBS’s currency traders have been suspended as part of an inquiry by global regulators into suspected manipulation of foreign exchange markets. The regulators, which include the UK Financial Conduct Authority, America’s FBI and Switzerland’s FINMA suspect that global banks including RBS colluded to manipulate exchange rates in the global, $5.3 trillion a day, foreign exchange markets. RBS has provided the FCA with e-chats that a former senior RBS dealer – Richard “Dick” Usher who left the bank in 2010 – had with traders at other banks. The traders’ group was variously known as “The Bandits” and “The Cartel”.
Ross McEwan will address the Business in Parliament conference in the Scottish Parliament on November 21-22