RBS to review its presence in Asia

In connection with its 2008 earnings release, the Royal Bank of Scotland yesterday announced a restructuring that will see it review its position in 36 of the 54 countries in which it currently does business and significantly reduce its presence in Asia. The global banking and markets (GBM) division will also be restructured and further layoffs will be announced.

On a total income of £26.9 billion ($38.4 billion) for the year, down 20% over 2007, RBS posted a loss of £8 billion before the write-down of goodwill and £24 billion after write-downs. The financial numbers announced by RBS had already been digested by the market in the month that has elapsed since January 19 when the bank released preliminary results and announced a bailout package that saw the UK government's stake in the bank increase to 70%. Constant leaks had alerted the market to the restructuring but the announcement yesterday was a stark reminder of the serious steps that financial institutions are taking to dig themselves out of holes.

It emerged yesterday that the results declared by RBS took advantage of the change in international accounting rules which allows banks to reclassify financial instruments and, from that point on, stop recording their falling value in the profit-and-loss account. The rule change, published in October 2008, put simply, allows banks to ignore the plummeting value of certain instruments until maturity on the assumption that the bank intends to hold on to these securities. Without the reclassification, RBS would have reported a further £5.8 billion loss on these investments. After accounting for adjustments related to write-downs on part of the portfolio, RBS's net loss would have increased by £3.2 billion.

"All our divisions were profitable except global banking and markets and Asia retail and commercial banking," comments Stephen Hester, group chief executive officer, in a written statement.

Hester goes on to say that even in GBM some businesses performed strongly, but this was "more than wiped out by credit and market losses in concentrated areas around proprietary trading, structured credit and counterparty exposures". He attributes more than 50% of the losses to portfolios originated by ABN AMRO, making it quite clear where responsibility for the loss is being pinned.

"Of 170,000 employees, around 500 are responsible for the loss," says a source close to the situation. "Even within GBM, rates and currencies had a blockbuster year but it was wiped out by credit market and equities losses."

Consequently, GBM is likely to see the largest restructuring, Hester says, with "a substantial shrinkage of size, product and geographic scope". Within GBM, RBS will discontinue illiquid proprietary trading activities and correlation trading in equity and credit markets. It will scale back activity in structured real estate, leveraged and project finance and exit lending in these areas entirely.

RBS is shifting £240 billion of third-party assets, £145 billion of derivative balances and £155 billion of risk-weighted assets to a non-core division with the intention of selling or winding down these businesses over a three- to five-year horizon. Around 90% of the non-core division consists of GBM assets.

In addition to eliminating expenses related to the non-core businesses, RBS is targeting cost savings of £2.5 billion, representing 16% of the 2008 cost base. This is to be achieved through "reengineering and other measures and, regrettably, reductions in employment," explains Hester.

This suggests another large round of job cuts will be forthcoming at the British bank. In total, RBS had around 174,000 employees at the end of 2008. This falls to 142,300 people if you exclude GBM and the Asia businesses, which are presumably being dealt with separately based on the strategy for these businesses (so, for example, GBM headcount cut will be related to departments being closed). Making a simplistic assumption that a 16% reduction in cost translates into a similar reduction in staff, RBS will shed approximately another 23,000 jobs.

Meanwhile, RBS intends to sell or significantly reduce its operations in 36 of the 54 countries in which it is currently present and enhance focus on its UK business. Consequently, Asia is in the firing line. RBS said its retail and commercial banking franchise in Asia is thinly spread and has not yet achieved significant scale. Options including a sale are being considered. The business contributed only £1.2 billion of revenues, less than 2% of overall revenues in 2008.

"The Asia franchise is currently not differentiated enough and, further, requires large investments in the near future," says a specialist. "It does not meet the scale and return on equity criteria." RBS has formulated five criteria to determine which businesses are core and will continue to see further investment, namely: competitive positioning; 15%+ return on equity; use of balance sheet, risk and funding; ability to grow organically; and connectedness to the RBS group in terms of customers, products and people.

RBS Coutts continues to be a core business in Asia. In 2008 the private banking arm generated 19% income growth in the region, grew assets under management in the wealth business by 8% and showed 5% growth in client acquisitions.

Morgan Stanley is advising RBS on the alternatives for its Asia franchise. RBS would like to cherry pick what parts of Asia it retains and not exit the business across the region, say sources, but it is not clear whether buyers will be forthcoming for piecemeal assets.

It was not all doom and gloom, however, as revenues in global transaction services improved in 2008 and were steady in regional markets. Hester also said that 2009 has started well for all of RBS's businesses.

RBS's share price gained 25.5% to 29 pence in yesterday's trading. It would seem investors had already digested the loss indicated in January and the announcement of the comprehensive restructuring removed the overhang.