FTSE 100
Dow Jones

Friday, 7 August 2009

RBS : again not what it seems

Why is it that as soon as governments get involved with banks they start lying about their results?

That was a rhetorical question. I know the answer. At the moment, politicians like to talk down the profits of the banks they do not control and talk up the profits of the ones that they do. Earlier this week Lloyds (LON:LLOY) were telling the world, or the government and the BBC were telling the world on their behalf, that the 43% government owned bank had lost £4 billion on a pro-forma basis, when Lloyds' statutory accounts actually showed a £7 billion profit.

Now we see the 70% government owned RBS (LON:RBS) telling the world that it made a £15 million profit, when its statutory accounts clearly show that the profit attributable to the RBS shareholders after stripping out all the dividends due to the minority shareholders who are caught up in the ABN/Fortis mess is not actually a profit at all but a £1 billion loss.

But that £1 billion loss includes a £3.79 billion gain from the early redemption of large chunks of RBS debt at a discount to par. Smart move you might think, even though it is only possible because the RBS asset book is reducing and there is cash available to repurchase debts (just like Barclays reported earlier this week). But just like Barclays this is largely illusory, because if RBS want to grow their balance sheet in the future, they are going to have to issue debt at the future prevailing yields rather than the lower yield on the debt they have just retired.

To understand this scam, imagine that 5 years ago a bank issued £100 of 15 years securities at par paying a coupon of 5%, but 5 years later the yield on that banks debt has risen to 6%. That implies that the securities could be repurchased in the market at a discounted price of £92.64, giving a profit of £7.36. Independently, but not completely independently because it has to pay for the bonds it retires, the bank goes back to the market to raise some funds. It might be weeks or months before or after the bond repurchase, but let us assume market condittions are similar, and the bank borrows £100 for 10 years at the market rate of 6%, which means that they will pay a total of 10 more in interest than they would have had to pay if they had not retired the 5% original bonds.

This week we have seen both Barclays and RBS book substantial profits on the retirement of their own debt. More than likely, this upfront gain will result in a larger increase in funding costs spread over many years. So figure that the realistic result for RBS for the last six months is closer to a £5 billion loss than it is to the reported £15 million profit.

No comments: