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Treasury Committee - Minutes of EvidenceHC 73
Taken before the Treasury Committee
on Tuesday 15 May 2012
Mr Andrew Tyrie (Chair)
Mr Andrew Love
Mr Pat McFadden
Mr George Mudie
Mr David Ruffley
Examination of Witnesses
Witnesses: Adam Young, Co-Head of Equity Capital Markets Advisory, Rothschild, Graham Webb, Director, Solid Solutions, and Manus Costello, Managing Partner, Banks Research, Autonomous, gave evidence.
Q1 Chair: Good morning. Thank you very much for coming in and helping us with our inquiry into what used to be known as privatisation but is now, on grounds of fashion, more often called asset sales. It is appropriate that we should be meeting in the Thatcher Room to discuss this, and we certainly have some big sales to think about. I would like to begin by asking Mr Young if he thinks that the current share price, particularly for RBS, is depressed to any degree by the scale of the public ownership.
Adam Young: I think it is fair to say yes. When the rumour arose a few weeks ago that the Abu Dhabi Investment Authority was going to buy a big tranche of shares in RBS the share price immediately reacted on the day. I think that was a reflection of investors’-and the research and sales community amongst the brokers-perception of risk. In particular, I think to a large extent it embodies key-man risk, a perception of key-man risk, that the management of RBS wants some more freedom to manage and that this would have been the first step on the journey.
Q2 Chair: Is a key number 50%? If we get below 50%, we get that lift?
Adam Young: I think you get a lift in advance of that. You get a lift from starting the journey of disposals and the first step will have an impact and further steps will have an impact after that. Like most risk issues, it is very difficult to quantify it in terms of value that is going to last for many months. There is definitely some uplift there.
Chair: Don’t feel the need to repeat what you have just heard but if you disagree-either of the other two witnesses-please say so now. Otherwise I will move on. All right; so there is agreement on that point.
Q3 Mr Mudie: Mr Costello, should the taxpayers be pleased at the speed of progress in turning round RBS?
Manus Costello: The progress that they have made on their strategic plan has been very impressive so far. I think there has been an enormous reduction in the non-core assets, which has been ahead of plan and within their guideline of losses expected. There is a different regulatory and macro environment now from what there was at the start of the plan. Therefore, they have made a rational decision to change their strategy and for their strategy to evolve. But I think, yes, the progress made on the balance sheet, in terms of capital, liquidity and de-risking, has been very impressive so far.
Q4 Mr Mudie: Does strategy suggest seeing a future in the UK, an almost ring-fenced side of the Vickers’ suggestion? Is that a good strategy? Would it be more difficult to sell it if they are intending to run down their investment arm?
Manus Costello: The changes with Vickers, and I would say also Basel III, and the other changes on the regulatory side that came in, led certain areas of the investment bank to be non-viable and I think they took a rational decision to run those down. The fact that they decided to run those down was shareholder-value accretive. Indeed, to come back to share-price reactions, if you look at the share price reaction to the announcement of that plan from RBS, the market responded very positively to it. So reducing the size of the investment bank in response to the regulatory environment can be a shareholder-value enhancing strategy.
Q5 Mr Mudie: So you say even post-Vickers, a lower presence in the investment side would be more profitable for RBS and other UK banks?
Manus Costello: I was talking specifically for RBS, and I was talking specifically to the plan that they put in place to reduce their reliance on wholesale funding and, therefore, minimise the impact from Vickers. I don’t think that was an irrational decision. I think it was the right one given the circumstances they found themselves in.
Q6 Mr Mudie: How far away from sustained profitability do you think RBS is?
Manus Costello: On my numbers I have them returning to sustained profitability next year. I would caveat that with the fact that analysts’ estimates are volatile; macro conditions are clearly very volatile. However, the sheer size of the losses being generated by the non-core division should reduce substantially next year and I would hope that they should be sustainably profitable from next year.
Q7 Mr Mudie: What more do Lloyds have to do before they are ready to be sold?
Manus Costello: Lloyds is in a different position from RBS, partly because of the size of the Government stake and partly because of the nature of the business model itself. They have also made some good progress in reducing their funding risks. There remain a lot of risks surrounding the UK macro environment and the asset quality of some parts of their book, and I think over the course of the next couple of years they need to demonstrate that they can build their capital ratios and manage their way out of some of those non-performing exposures. That is what they are on track to do, and obviously a large part of the outcome will depend on the UK macro situation as much as anything else.
Q8 Jesse Norman: Mr Costello, can you just talk us through the shape of the RBS balance sheet at the moment because there are obviously several impediments sitting in there to possible privatisation and the challenge to it?
Manus Costello: Do you mean in terms of the share capital structure?
Jesse Norman: There are several aspects, but let us start with the dividend access shares.
Manus Costello: RBS has a number of different share classes, which make re-privatisation a bit more complicated. There are straightforward A shares. There are then the B shares, of which the Government owns 100%. There is then this instrument called the dividend access share, which is a very complex instrument that I can explain the ins and outs of if you want, but to all intents and purposes it blocks a dividend for RBS being paid to equity shareholders for the foreseeable future. To my mind that is one of the key impediments to a re-reprivatisation that has to be addressed.
Q9 Jesse Norman: Then what are the steps in order to get rid of that? You have to get rid of that; you have to do something about the A and B shares, presumably, or would the A shares and B shares be merged in some way? What are the steps to privatisation?
Manus Costello: You have to get rid of the dividend access share and there are various ways that you could do that. You could simply pay a cash payment to get rid of it. You could somehow increase-
Q10 Jesse Norman: That is writing a cheque to the Government?
Manus Costello: Correct.
Q11 Jesse Norman: How much for?
Manus Costello: If the dividend access share itself is a complex instrument, the valuation of the dividend access share is even more complex. The last valuation that UKFI put on it was £2.3bn in March last year. As I say, the inputs into that valuation model are volatile and complex, so I wouldn’t say exactly how much that settlement would be reached for.
Once you get rid of that, the A share, B share structure is not necessarily an impediment to sale, because in theory you could sell the A shares and then move on to the B shares. In theory you could even sell the B shares if you wanted to. From an investor perspective, I think what the markets want to see is a simple equity shareholder structure with a dividend-paying capacity that can be sold as a clear investment case, and while you have these different classes of share, that is blocking that.
Q12 Jesse Norman: You also have the asset protection scheme, don’t you? That would have to be resolved before it could be privatised. How would that work?
Manus Costello: Yes. The base case at the moment is that RBS will be leaving the asset protection scheme in October. That is the market’s assumption, because fees have been prepaid up to the beginning of October. The requirement for the risk-weighting relief they get from the asset protection scheme and the protection they get from loss sharing under the scheme is much lower now, so the base case assumption is that the asset protection scheme will no longer be part of RBS by Q4 this year.
Q13 Jesse Norman: What kind of capital would they have if they are getting out of the APS and writing a large cheque for the dividend access fee?
Manus Costello: Obviously, it depends on what size of cheque they would have to write for the dividend access share. On my numbers, there would be no capital requirement from leaving the APS, and I think, depending on the range of valuations that the dividend access share were bought back for, if the way the market is projecting the earnings power of RBS over the next two or three years develops, there should be no requirement for additional capital. RBS is generally perceived in the market as being bottom first quartile, upper second quartile, in terms of its capital ratios, and therefore it should be able to withstand an exit from the APS and other capital changes.
Q14 Jesse Norman: Let me understand that, because what you have said in some of your research is that there is going to be a hit to book value by £1.3 billion. They are going to have to write a £2 billion cheque to the Government. Are you comfortable they will be able to fund themselves? What would the requirements be on the new capital?
Manus Costello: In my research I took a central range of scenarios for what the dividend access share might be paid out at. I also looked at what requirements may be made for RBS when it leaves the APS in terms of contingent capital. The hit to book value, which you are referring to, the £1.3 billion that I was talking about was specifically about whether or not they are required to increase the contingent capital base that they have outstanding at the moment rather than the actual equity capital base.
Q15 Jesse Norman: Your view is that they would have to?
Manus Costello: My view is that it is likely that some kind of change on the contingent capital is asked for by the FSA.
Q16 Jesse Norman: Are there any other technical requirements that would need to proceed before privatisation could take place or the sale of the shares?
Manus Costello: Even these are not technical requirements that would need to be met; they are I think just in terms of developing the story for the market, but beyond that, no. It comes back to straightforwardly presenting a bank that has returned to sustainable profitability and can pay an equity dividend.
Q17 Michael Fallon: Mr Young, to what extent has the Government’s ownership of the majority stake in RBS been corrosive?
Adam Young: It is not so much the fact that the stake has been held by the Government that has been corrosive as much as the regulatory uncertainty generally. In my earlier answer, I mentioned that one of the big worries that investors generally have about RBS is key-man risk, and the senior management team staying in place to complete the job, which they have started, in repairing the balance sheets, slimming the business down, getting the capital ratios in the right place and providing a platform for solid, sustainable returns. To the extent that the politicisation of the activities of RBS starts to threaten that, I think that does pose a threat, which institutional investors are nervous about, and I am sure that the gentlemen who will speak to you in the next session will confirm that.
Q18 Michael Fallon: Did the row over Mr Hester’s bonus damage investor confidence?
Adam Young: It ratchets it up another level, yes.
Q19 Michael Fallon: Does retaining and recruiting key personnel become more problematic the longer this thing stays in public ownership?
Adam Young: That does become more and more of an issue, particularly in the very senior management positions that have such public focus at the moment in the media.
Q20 Michael Fallon: For example, if Stephen Hester felt he had to resign or was driven out by this media hoo-ha over his bonus, how damaging would that be to the share price?
Adam Young: I think it would be a real challenge to find a replacement. Let me just rephrase that. I think the perception is that there would be a struggle to replace him, given those pressures that might have forced him out.
Q21 Michael Fallon: What more can the Government do, aside from what they have done with UKFI, to reassure investors that RBS is being run on commercial grounds?
Adam Young: I do think the start of a monetisation programme is really the acid test, because in the final analysis, that is the programme that signals normalisation. The more that the Government can talk in practical terms about readying the bank for the public markets-or the 82% that is not already held-the more people will see that Government is taking a pragmatic view to studying the real issue.
Q22 Michael Fallon: Mr Costello drew attention to some of the differences between Lloyds and RBS. Apart from the size of our stake in these banks, what do you see the other differences between the two banks are so far as their ability to operate on a commercial basis is concerned?
Adam Young: The Vickers Report, and the implementation of the Vickers Report, has a fairly significant impact on the way that the investment banking and the corporate banking parts of the RBS business are perceived by the marketplace, because there is no absolutely clear view about how the implementation of that regime might affect management’s view of the economics of that business. That is a big unknowable. It is very difficult for an institutional investor, whose job is to earn investment returns for the investors he serves, to be able to buy a large amount of shares with that big unknowable in the middle of the equation.
For Lloyds Banking Group the impact of Vickers is much less profound. Clearly they are a consumer-driven bank more than a corporate-driven bank, in terms of the overall business. Then when it comes to dividends overall, I think it is fair to say that Lloyds are perceived to be nearer paying a dividend than RBS are. In their last results announcement, they guided the market to expect that Lloyds would continue to use retained income to build up their capital reserves but, once they felt that they were in a prudent position, they would be able to start paying dividends, and they don’t have the structural construction of the dividend access share.
Q23 Michael Fallon: Given that for institutional investors so many of these mandates seem to be global now rather than national, how will that affect the perception of these two banks?
Adam Young: You are absolutely right. The fund management industry becomes less and less parochial by the day. These fund management institutions have the ability to invest in banks anywhere in the world, so to the extent that an investor feels that he can gain his access to the financial sector part of the global economy through some other route, at lower risk, then he is going to choose that.
Q24 Chair: Following up on one point Michael asked about UKFI, if Government share ownership is depressing the share price then clearly the UKFI firebreak is not as good a firebreak as it could be. What you appear to be telling us is that there is nothing that can be done about that. Is that right?
Adam Young: The issues that need to be solved in order for RBS to be privatised are beyond the UKFI’s immediate ability to resolve. I think that is the financial circumstance.
Q25 Chair: You are going a bit further than that, aren’t you? You are saying that there is a perception in the market of Government interference, notwithstanding the arm’s length UKFI holding arrangement.
Adam Young: There is a lot of public interest in what RBS does.
Chair: Try not to be a politician. We would just like to have an answer.
Adam Young: There is a lot of comment by Members of Parliament and by the media on what RBS does, and UKFI can’t do anything to stifle that. From the point of view of the financial sector’s view of UKFI as a firebreak, I think our perception is that they have done a very, very good job out of a difficult situation, in particular taking the heat out of some of these issues as best they can.
Q26 Chair: More power to their elbow?
Adam Young: I think so.
Q27 Chair: Yes. Does anybody want to add anything to that? Mr Webb?
Graham Webb: I would just suggest it is better that they are there than they are not there. Government ownership is a fact, and the UKFI consists of people who understand the market. They are ex-market participants themselves and they are good interlocutors with the market.
Manus Costello: I would just add from an analytical point of view, the banks have moved to disclosing a lot more information. I don’t know, but I suspect that some of that pressure has come from UKFI, and ultimately that increased disclosure should give the market more confidence in the banks. The UK banks have gone to very much best in class on a European scale, in terms of the disclosure they now give, and I think UKFI probably played a role in that.
Q28 Chair: Do the markets believe that the Government are pulling the strings? Or is it just a concern that they might? Or do they think UKFI really is running these things on behalf of the Government?
Manus Costello: For example, if you look at the major strategic decisions that have been made by RBS over the course of the last few years, whether that was creating a non-core division, whether that was changing the funding structure and the recent decision to run down the wholesale bank, I think the market believes, correctly, that those were all strategic decisions that were taken because they were the right commercial thing to do for RBS management and for RBS shareholders. There clearly have been some signs that commercial strategy is being influenced by public pressure, the CEO’s compensation being an obvious one during the course of this year.
Q29 Chair: Public or Government pressure? I have been asking about the Government all the time and both of you have been replying with the word "public".
Manus Costello: What happened earlier this year was as much about a public reaction as it was about a Government reaction, to be honest. It was as much about a popular press reaction as it was about a Government reaction.
Q30 Chair: To which the Government also felt the need to respond in some way.
Manus Costello: The sequence of events is probably better known to you than it is to me.
Manus Costello: But to your point, I do think it is important to stress that investors’ fears are more about the potential for future interference than current interference. That is really where people are concerned. There is a fear across the whole European banking sector that sovereigns and banks are becoming more intertwined and that that will lead to non-commercial decisions being taken.
Q31 Mr Love: Can I move us on to the sale price. There has been an almost automatic assumption that the only criteria to consider here is breakeven. Is that the best criteria? Is that the most efficient outcome for this or should we be looking at other criteria?
Adam Young: The first comment I would make is that all Governments around the world that have had to execute some form of bailout of banks or other companies through the financial crisis, are facing the issue of the breakeven price being this extremely prominent price that everyone at least puts focus on even if they are not explicitly saying that that is the price that has to be met. Whatever one does, the breakeven price is going to be an important consideration in the strategy, simply because members of the media will be seeking to make a story out of it even if Members of Parliament do not.
In fairness, in a lot of the Government advisory work that we do at Rothschild we do also try and focus on the potential monetisation proceeds from an overall programme of disposals. If one is faced with a disposal programme the size that RBS and Lloyds Banking Group could potentially be, probably that is going to have to be structured as a number of different sales taken over a period of time probably during which the economic cycle is turning to a more positive trend than we are seeing today. The art of this is really to try and model scenarios under which the whole programme of sale would be capable of exceeding the breakeven.
Q32 Mr Love: I want to respond to that but before I do, when they appeared before this Committee UKFI said the share price being breakeven was not the only factor. Commenting on what you have said, what other things should be taken into account?
Adam Young: What I was trying to say in my last answer was that, throughout the whole programme of sales, one would achieve proceeds approaching the breakeven, but that does not necessarily mean that the first transaction would be at or above the breakeven price. Clearly that whole strategy would need to be worked out in detail. I am not in charge of that strategy, but that would be the sort of work that I would typically be doing for a Government looking at a monetisation programme such as we have here.
There are instruments that one can use in order to achieve a disposal price at a breakeven level that is perhaps above the current share price. There are instruments called convertibles. Essentially these are bonds that pay income to an investor and they are convertible into shares at a price above today’s price. Effectively what that gives the investor is extra income today and a bit less upside tomorrow, but quite a lot of equity upside beyond that, and it reduces the risk for the investor today. Those sorts of instruments can be used even when the stock price is not that close to the breakeven level.
Q33 Mr Love: Let me press you a little on what you have said. It is clear that when the Government bought both RBS and Lloyds it paid different prices at different times for the shares, so theoretically you could sell the first tranche at lower than the breakeven price and further tranches hopefully. However, there is quite a lot of market sentiment out there suggesting that, in the current circumstances and the climate of uncertainty that we are in, they can never achieve breakeven. How do you respond to that concern?
Adam Young: What are the unknowables? One unknowable is the economy, and we have had a false dawn or two since 2009. The other unknowable is the eurozone and what that might do. If that truly causes problems in the European banking system, what impact might that have on provisioning within RBS and Lloyds and the banking system overall? Then you have regulation on top. You have lots of levels of unknowables there, and in the situation today we would be looking at the current share price; we would be looking at the breakeven price and saying that there is a big gap to be bridged.
What I would say is that other Governments have found-particularly when they hold cyclical stocks like banks-that if they can wait it out, at least for some of their monetisation transactions, the economic cycle actually does have a significant impact, not only on the bottom line of the banks but also the multiples that investors are prepared to put on the bottom line in terms of valuation.
Q34 Mr Love: The reality is that everyone recognises if both banks were very profitable you would see that reflected in the share price. That is somewhat away in terms of timing. Let me take a year; 2015. Realistically, is there any possibility that by that time we will have been able to sell the shares of both banks at the breakeven point?
Adam Young: All of them?
Mr Love: All of them.
Adam Young: I think there is a low probability of that.
Q35 Mr Love: So if I take the case of Sweden, which nationalised its banks some considerable time ago and still has a major shareholding, is that the likely prospect for the UK?
Adam Young: It is quite possible it may take seven-I am taking numbers out of the air here-but it could be more than five years. If one looks at international analogues, and there is one that I was looking at the other day. For example, Continental Illinois Bank in the United States went bankrupt in 1984. That was the largest ever bankruptcy in the US. At the time it was the seventh largest US bank, and the US Government effectively nationalised it, recapitalised it and put it back on the market. That whole sequence of events took seven years from start to finish, and that was in the hands of a Government that really does not see its job at all as holding any sort of listed stock.
Q36 Mr Love: Can I ask the other two witnesses-
Chair: Briefly. We are going to be moving on in a minute.
Mr Love:-if they have any comments to make on whether breakeven is realistically possible, and if so what sort of timescale are we talking about in terms of sales?
Graham Webb: Not on the specific point about proceeds. You did mention UKFI’s earlier comments, and I would say that, in my experience, the maximisation of proceeds, whether it is above breakeven or not, is generally not the only consideration, the only objective or measure of success of a Government when pursuing asset sales. They don’t happen in a vacuum. There is a political cycle. There is a business cycle. There can be a philosophical desire not to own shares in a private company, and all of these other aspects can sometimes be weighed off against the ideal financial objectives.
Chair: A quick response, Mr Costello.
Manus Costello: I would just point out that my current valuation of RBS is about 30p. The range of market valuations for RBS is between 20p and 40p. No analysts currently value RBS at above the breakeven price, which would suggest that it would be quite a long haul to achieve the breakeven price. I would also point out, of course, that the further away the breakeven price is in terms of the realisation, the less it is worth in terms of present value today.
Q37 Mr McFadden: In this theme about the relationship between the timing of any sale and the price, Mr Webb, could I ask you about the rumours a few weeks ago about Abu Dhabi’s investment fund being interested? Is it your view that an early sale, even at a loss, is an advantageous thing to do because it sets a sense of direction and perhaps gives a more realistic idea of what the real price of the shares is, because at the moment we have this huge stakeholding in RBS and very small volumes of shares being sold to private investors?
Graham Webb: I can really only answer that as a man in the street, or perhaps as a retail investor might view it. From a capital markets point of view, Mr Young may respond better than I. But from the man in the street and the retail investor’s point of view, a strategic stakeholder really has to be explained very carefully as to what the benefits are for the overall sale process, and perhaps too for the beneficial effects that it will have on the share price and the proceeds gained over the longer term. Anything that looks as though the strategic stakeholder is really an investor that is getting a preferential deal in some way, and can make a relatively quick turn on it-I am thinking of the experience of Abu Dhabi with Barclays, for example-is not one that is going to look good in any way, shape or form. But again, that is such an obvious point I am sure that it will not be a mistake that would be made.
Q38 Mr McFadden: Mr Young, what is your view of this kind of fast move, if you like?
Adam Young: Of an Abu Dhabi investment?
Mr McFadden: Yes, or someone similar like that, an institutional stake.
Adam Young: There are two angles to it. There is an overall policy-structure angle and there is also the desirability of placing stock with funds like Abu Dhabi.
From the point of view of overall strategy, I think it is good strategy to start a disposal programme with the first tranche of the disposal at the lowest price and build it up over time. That is the tried and tested way of disposing of very large blocks of stock in several tranches, and encouraging investors in the first tranche to reinvest in the second and to broaden the investor base for the second because the first was successful. It is kind of straightforward psychology. Obviously there are costs, in terms of value of selling something early at a cheaper price and Government will need to be comfortable with that.
From the point of view of sovereign wealth funds, of course they are a new phenomenon. As early as 1987, we saw the Kuwait Investment Office buy a large stake in BP after that privatisation transaction-quite a controversial one-so they have been a feature in the capital markets for quite some time. Nowadays these funds are professionally managed. They are able to deploy very large amounts of money in single investments. I think that is their use, the fact that you are effectively only having to convince one buyer that the risk/reward is right rather than multiple buyers in a broader offering. Sometimes-sometimes-if they happen to be taking a more positive view of some factors, the price can be better than you might get from the broader community of institutions for whom the lowest common denominator might prevail.
Q39 Mr McFadden: Can I ask you more about this issue of price? As Mr Love said, the taxpayers bought these shares at a certain price, about 50p. Obviously the taxpayer wants their money back.
Adam Young: Understood.
Q40 Mr McFadden: Stephen Hester said that the share prices of Lloyds and RBS might start to improve once the sale process begins, which is similar to what you were just saying in your first answer. Do you think it is likely that an early sale, even if the taxpayer is taking a hit on that, would mean that subsequent sales would then be at an increased price? Why should that be the case? Why should an early sale at a loss indicate that there would be a price increase after that?
Adam Young: In isolation it would not mean that automatically there would be an increase in value. I think one would try and time the sale whenever it took place, such that-let me try and express it a different way. As the manager of the sale of a stock, the UKFI, when it comes to it, will be trying to assess timing in terms of: is the story and the market sentiment getting better and are the risks coming down? I think they would need to be confident that the sale at a loss was a means to an end; that there would be later sales at higher values and that there were very clear pointers to that happening in the foreseeable future. It is not the case that they would be just saying, "We will take a total opportunistic approach to this". So, from a public policy point of view, probably one would want to try and justify that a loss is worth taking today because it is part of a programme that we-
Q41 Mr McFadden: What is your view? I am afraid we have no money to give you a fee for this advice. We are going to have to ask you for it for free today. But if you were advising the Government would you say that that kind of approach is worth doing, given that the share price has failed to come anywhere near its initial buy-in price since the state bought its stake?
Adam Young: What I would say in response is if you look at what happened in the latter half of 2009 and 2010, in terms of the rise in values in UK shares overall-and it was a strong rise; I can’t remember exactly how much it was, but the market rose by several tens of per cent.-that was a reflection of perception that risks were declining. It may have been erroneous but that was their perception at the time. I think, in terms of structuring a programme of sales, one would want to put the first sale maybe at the bottom of that ladder.
Q42 Mr McFadden: I am not sure if that is a "yes" or a "no".
Mr Costello, you gave us written evidence which-if I can summarise-effectively said, "Forget about this 50p. We are not likely to get it. The state has to face up to selling these shares at a loss". Is that your view?
Manus Costello: I would not completely agree with that summary. I would say that your question, as to whether or not an initial sale should be contemplated at a loss, comes back to the Chairman’s question earlier, I think, about the fear of the bank being able to manage itself along commercial grounds. I think there is a market perception that if there were another investor, or another group of investors, within RBS or Lloyds, that would encourage the bank to be run more along commercial lines, would reduce the risks of further interference and therefore reduce the cost of equity and therefore, hopefully, make the share price go higher. What I was arguing in my research was that, in my view, if we stick to the breakeven price as the only criteria, and don’t accept that there is any risk of achieving below the breakeven price by making an initial sale, it will create significant problems over the longer term.
Q43 Mr McFadden: I suppose if I can ask you the same question I asked Mr Young, if you were sitting in front of the Chancellor, who was asking you for your advice on this at the moment, would your advice be you have to set aside this breakeven price and contemplate at least an initial sale at below the 50p price, because that is the only way you are going to be able to start re-privatising this bank?
Manus Costello: The initial piece of advice would be that, in the current market conditions and with the current capital structure of RBS, any sale is very difficult and this is not exactly the right time to start it. But as a principle, yes, that would be my advice, that starting a sale transaction should be accretive to the value that the taxpayers can get out of the overall investment in RBS, and you are more likely to get a better value if you accept that principle rather than hold on for breakeven as your initial sale price.
Q44 John Thurso: Mr Costello, can I ask you, virtually all the discussion this morning, and most of the discussion in the financial press and so on, has been based around a sale by the Government of a stake over a period of time and how that might be done, but there are a number of other options that have been put forward, and I wanted to ask whether you had done any research on those. The first one is the idea of breaking RBS up into its two basic component domestic brands, RBS and NatWest, a merchant bank and a back-of- house operation that could even facilitate other new entrants. Have you done any research or given any thought to that possibility?
Manus Costello: Not specifically, but I would note that if you look at the capital allocation of RBS, over 70% of the capital of RBS at the moment is allocated to wholesale banking divisions in the UK and internationally, to Ireland and to its non-core division. If you are talking about breaking up RBS, you need to bear in mind that those wholesale banking operations that suck up a large proportion of the capital may be more difficult to sell and may be left with the state, so it is not a straightforward operation. I would also note that breaking up a large global wholesale bank is not a straightforward operation. It has been tried before. Indeed, it has been tried before by RBS, and I am not sure it is an experience-the ABN AMRO experience-which would necessarily want to be repeated. There is a risk of significant stranded costs remaining. There is a risk of execution being below what you hoped for. I think it is a strategy that sounds interesting but in practice, when you look at where the capital of the bank is actually allocated, it could be value destructive for taxpayers.
Q45 John Thurso: The real drawback to that option is it crystallises the bad elements of the bank in an unsellable portion, it makes it very difficult to sell?
Manus Costello: That is certainly one of the key risks, or that businesses, which make sense within the global universal bank structure of RBS, stripped of other elements of the bank those may not be so attractive any more.
Q46 John Thurso: Can I ask the other two witnesses, is that something you concur with or is it something that you would give thought to other views on?
Adam Young: Certainly I would concur. As a corporate financier, I would say demergers, splitting businesses apart, are the most difficult and most time-consuming types of transaction we do. The process of doing that would take many months; many months under which the staff of the bank would be concerned about the final outcome and their future. There is also the element of diversification of the bank in general. RBS would argue strongly that they would operate best as a retail and corporate bank combined-that is how they would best produce returns in different types of economic conditions.
Q47 John Thurso: Can I turn to Mr Webb and to another option that has been put forward in a paper by the Centre for Policy Studies. Effectively, that is a distribution of the shares broadly to all taxpayers at a price where they exercise the option when it crosses the threshold. Have you had a chance to study that option and what would your advice be on it?
Graham Webb: Yes. When this option came out into the open and started to get a bit of traction, then we at Solid Solutions from a practical point of view, and also Barclays Capital from a capital markets point of view, did a bit of work with Portman Capital-who are the originators of the scheme-to look at it and see if it was workable at first sight. We have done some work, and indeed it looks as though it could be made to work. The objective that it sets out to do, which is broadly to improve the price that the Government might get for the shares, works in theory. I think all parties realise that there is more work to be done to validate that at the moment, but it is an option that bears more work and scrutiny.
Q48 John Thurso: That is considered a viable option?
Graham Webb: Subject to getting really under the bonnet and committing quite a lot of time resource to having a look at it.
Q49 John Thurso: You had some experience with the sort of "Tell Sid" right at the beginning and the widespread retail-
Graham Webb: Yes.
Q50 John Thurso: Of course the problem with that is it tends to be sold on very quickly, and you end up with a small gain to particular people rather than what this policy would seem to be wanting to do, which is actually to spread it.
Graham Webb: Yes. It is very different from even those types of "Tell Sid" campaigns you mention of the late 1980s and early 1990s.
Q51 John Thurso: So your advice to the Chancellor would be, "Don’t tell Sid"?
Graham Webb: No, not at all. "Tell Sid" is a bit of a cliché. If you look back, it was more than just a huge advertising campaign, it was an environment. It brings to mind these old fixed-price share offers that were "priced to go" by the Government. Effectively, people signed up to buy these shares and were practically guaranteed a profit and that is why they were so popular. I think that type of "Tell Sid" campaign, which gave retail investing quite a bad name because a lot of people stagged the offer, has gone forever.
But I would hark back to similar types of offers-the book-built secondary share offers of the second and third tranches of BT and National Power and Powergen in the early 1990s. They were book-built offers. They were secondary offers, as RBS and Lloyds Banking Group would be, and equally highly marketed-I don’t know if you remember Maureen Lipman as Beattie on television, and that sort of thing-with incentives for retail investors -- bonus shares and so on. Fewer people took part, but because they were book-built offers, and built against the market price of the shares, they were much more tightly priced, therefore people did not sell out in the same sort of way. That is a valid option. That type of sale is a valid option for UKFI and the Treasury to consider as part of the mix of disposals.
Q52 Stewart Hosie: Mr Young, you spoke about a number of sales over a period of time. I am going to be very brief with these questions. Does that give me the impression that you would not want to see a big bang, one-off disposal? That you would prefer to see the disposal in a number of tranches?
Adam Young: Given the amount of stock that is for sale in both of these two banks, in terms of absolute numbers, it would be quite difficult to foresee the ideal market conditions that would permit a big bang sale-as you put it-at a price that was acceptable, I suspect- that is my gut feel. Having said that, in a Government privatisation programme, it is totally conventional to have one or two of the disposals as a very large transaction in the middle. As Graham said, one can involve retail as part of that formula, maybe using the Portman structure, maybe not. The key point is that the very large sales tend to be possible only when all the different risk elements are pointing in the right direction, so fund managers generally have cash to invest, retail investors generally have cash to invest, and the market outlook doesn’t look too bad so there is some appetite to put more money in; from the point of view of the performance of the two banks, the returns are on the rise, the internal risks are seen to be generally on the decline and one can project returns with a bit more confidence. If all of those things come together, then those are the circumstances when one can attempt a very large transaction, multi-billions of pounds’ worth of offering.
Q53 Stewart Hosie: I understand that. You are right that everything needs to be pointing in the same direction. In terms of doing it in tranches, which seems the most likely thing to do, what would the balance be? How many tranches would you anticipate? Is there space for a retail offering, whether it was a straight sale or the Portman option? What sort of proportion would be on the retail side and what would be on an institutional placement?
Adam Young: Can you remind me, the first part of your question was?
Stewart Hosie: If it was to be done in tranches, which seems likely-
Adam Young: Yes, how many tranches?
Stewart Hosie: -how many tranches would there be and how big would the retail offering be in among that?
Adam Young: Just talking about general precedent, it is quite rare that one sees an individual transaction of more than £5 billion. Maybe you could stretch that, if the conditions were completely in line, to £6 or £7 billion, but I don’t think you would really be contemplating transactions a lot larger than that.
Q54 Stewart Hosie: But that implies 10 tranches.
Adam Young: That implies a lot of tranches for these two banks.
You asked me a question about retail. The precedent for mass retail equity offerings is that when they are done and they are done with some intensity, meaning that there is a publicity programme, an advertising programme that accompanies the sale, then you can rely on between 40% and 60% of the overall offering being accounted for by retail. The sorts of transactions that I would refer to as relevant precedents would be a very large sale that the Australian Government did in 2006 with Telstra their telecommunications company, and also privatisation transactions, like the privatisation of Electricité de France in 2005, so both within reasonably recent memory.
Stewart Hosie: Just one final question.
Chair: With a quick answer, please.
Q55 Stewart Hosie: If there were these multiple tranches, which took a significant amount of time, what does that do in terms of adding risk to people who are further down the chain who want to buy a segment from a subsequent tranche, because market conditions can change? What does it do in terms of risk? How would you weigh that, measure that, store that?
Adam Young: In terms of your retail offering, you don’t want that to be the last trade you do. You want that to be one of the earlier trades that you do, when the risks are lowest and the growth is most evident. From the point of view of the latter trades, one can be very much more opportunistic. Generally speaking, Governments will be very, very quick to market transactions for the last tranches, quite often they can be underwritten by banks at very short notice.
Graham Webb: Can I just add to that?
Chair: Very briefly.
Graham Webb: No matter how many tranches you have it is possible to have retail involvement in all of them. They don’t have to be the big all-singing, all-dancing set piece events, which we discussed earlier. They can be much more finely tuned to the sort of quick offers, which-
Q56 Mr Ruffley: Mr Webb, you talked about the Portman Capital model and you said that there was a lot more work to be done on it. Overall, it is quite plausible, but one objection might be from the Government, which is that they don’t know when they are going to get the money back. What other objections, technically, could you outline for the Committee to the Portman Capital model?
Graham Webb: Very briefly, there is one of scale. Clearly the scheme works best if you try to engage as many people as possible in it. Similar transactions to date, in terms of involving people, have been about 8 million; the demutualisation of Halifax Building Society, that sort of scale. You might be talking about involving three or four times as many people if it was incredibly popular. Having said that, there is nothing new about the process, it is just a question of upscaling everything.
Secondly, there is time. We have talked about complex retail offers, which generally take about six months to organise and are probably out in the public domain for a couple of months before pricing. With the Portman scheme, again, because of the scale and some of the other novel features, I would expect that you would probably have to be pressing the button to proceed with it almost up to a year in advance, and the scheme itself might be out in the public domain for up to five or six months. In other words, it is very difficult to stop it and change your mind once you have started.
There is a reputational risk there. The scheme has to be made watertight. If it is seen to be easy to defraud, non-existent people signing up for it, or missing people out that deserve to be in it, that has to be combated.
You mentioned the uncertainty in terms of timing of receipts. That actually implies that there has to be an equally rigorous and plausible plan for winding the scheme up. At the end of the day, you don’t want it actually extending out for decades as people just sit on their shares and don’t get rid of them. Again, that has to be worked through in a very plausible and rigorous way.
None of those things are insurmountable. I would guess if I was sitting in the UKFI’s chair, their concern might be the lead times because, as Adam has mentioned, signalling what you are going to be doing to the market is not something that is generally beneficial.Having said that, the structure of the Portman Scheme is supposed to be that by making the institutional offer the last institutional offer there will ever be, that actually gets over some of these issues. It turns it into a sellers’ market rather than a buyers’ market, if I can put it in banking terms.
Q57 Mark Garnier: Adam Young, Graham Webb, you have a lot of experience in this realm of transaction, what do you think the fees would be chargeable on a disposal?
Adam Young: Low.
Q58 Mark Garnier: How much? Either a percentage or an absolute value?
Adam Young: Generally speaking, the fee scales on privatisation transactions are a fraction of what you see in the private sector.
Mark Garnier: You are avoiding the answer.
Adam Young: No. I am going to answer. For example, thinking of the very large Telstra offering that happened in Australia in 2006, on which I worked, the fee for that was 0.5%. Even in America, on the General Motors IPO that happened at the end of 2010, where normally fees are huge-
Q59 Mark Garnier: Corporate finance fees, underwriting fees, brokerage fees, clearing fees, legal fees. The whole lot. All of the fees have been coming in at 0.5%? You are saying that the entire fee scale would be 0.5%, for everything?
Adam Young: In that region.
Q60 Mark Garnier: It is still quite a lot of money.
Adam Young: It is a lot of money.
Chair: It is £250 million on £5 billion.
Mark Garnier:£250 million you are looking at.
Chair: On £5 billion.
Q61 Mark Garnier: On £5 billion, and this is, what, potentially a £45 billion transaction, potentially?
Adam Young: But what I would say is that the Government will use the full force of its position to get every single investment bank to compete, and they will compete on fees.
Q62 Chair: What, so they charge 249?
Adam Young: Well, no, I-
Chair: You would do it for 200, wouldn’t you?
Adam Young: I would do it for 200.
Q63 Chair: It is a big demand facility, my underlying point behind this actually is that there is a certain amount of friction between the wider public and the investment banking world.
Adam Young: That is understood.
Q64 Chair: Here is a perfect opportunity for the investment banking world to demonstrate goodwill for the wider public and offer to do a transaction like this for cost price, which would obviously not be £250 million.
Adam Young: Can I respond slightly differently? If you are talking about a very large complex offering with lots of moving parts and lots of people involved, then maybe that 50 basis points is the sort of quantum that that type of transaction might require. If you were looking at something smaller in scale, and more opportunistic in terms of the market execution, it would be perfectly possible to get banks effectively to underwrite scales for fees that are very, very slim basis points. Effectively, they would take the risk off the Government for the block and take responsibility for on-selling it. On those sorts of transactions, those sorts of risk transactions, I am sure what UKFI will be doing is getting banks to compete with each other to underwrite-
Q65 Mark Garnier: Yes. For the non-risk transactions, though. Clearly you have some base costs, but with the non-risk brokerage transactions, as opposed to the underwriting transactions, clearly there is scope for actually doing it at cost price in order to buy goodwill. Graham Webb, do you want to comment on that?
Graham Webb: Yes. In terms of retail tranches on past privatisations, the Treasury got itself into a position where these were not underwritten by the investment banking syndicate, so the costs were entirely those of distributing the shares to the general public, and similarly I would guess that would be about 0.5%.
Q66 Chair: Thank you very much for enabling us to get down to brass tacks before we finish and discuss fees. I want to ask, Mr Costello, if you would be prepared to flesh out the point you make-in writing, perhaps, to the Committee-the obvious point about the confusion between the 50p and the 41p as the strike price. The entry price that people should be using as the base price for working out-
Manus Costello: The entry price and the National Accounting price, absolutely.
Chair: Yes, that issue. That would be very helpful if we could have that unambiguously set out for us. Thank you very much for coming. It was extremely interesting.
Examination of Witnesses
Witnesses: Robert Talbut, Chairman, Association of British Insurers, Keith Skeoch, Chief Executive, Standard Life, and Richard Buxton, Head of UK Equities, Schroders, gave evidence.
Q67 Chair: Thank you very much for coming to give evidence to us this morning. How many of you hold shares in RBS or Lloyds? Perhaps I can just go through-all of you? Is that in tracker bonds because of their position in the FTSE 100 or from a more direct choice?
Richard Buxton: It is direct choice in our case. We don’t run tracker bonds.
Robert Talbut: In my case I am here representing a single institution, which is the Royal London. We hold them as a passive. But I am also here as a representative of the ABI, who hold them both in an active and passive nature.
Keith Skeoch: It is a direct choice. We are an active manager.
Q68 Chair: Have you been listening to the evidence that has just been given about the depression of the share price caused by the size of the Government ownership? Do you all agree with that?
Richard Buxton: I have listened to half of it.
Chair: Do you agree with the half you heard? I would not ask you to agree with the half you did not hear.
Richard Buxton: I think it is one of the elements, but it is only one of many elements that affect the share price.
Q69 Chair: Do all of you agree that if a way could be found of making UKFI demonstrably more independent of Government that in some way that might bolster the share price?
Robert Talbut: That would be one positive, but if more of the shares of the two banks were to be in private hands I think that would similarly be taken as a good thing by the markets.
Q70 Chair: Is there agreement on that point by all?
Keith Skeoch: There are two other issues that need to be taken into account.
Q71 Chair: Before we just move onto those, are we agreeing with that point? That is the thing I am asking.
Keith Skeoch: In terms of?
Chair: The point was: if we could make UKFI demonstrably more independent, would that itself make some contribution to dealing with the depression in the share price, which you agreed a moment ago is present.
Keith Skeoch: It would make a modest difference. I think there are two other things that need to happen for it to make a substantial difference.
Q72 Chair: Those are?
Keith Skeoch: First of all, markets and share prices are partly driven by sentiment, so tone is very, very important, and the tone of course is set at a very high level. For understandable reasons, the tone has been very anti-bank. If that tone persists it will make quite a sharp difference on the price. I think the other-
Q73 Chair: So taxpayers are losing out because they are bashing banks?
Keith Skeoch: Yes, essentially.
Chair: Your second point?
Keith Skeoch: The quality and clarity about the regulatory environment, which you spoke about at length. The clarity about the regulatory environment is incredibly important, and I think it is worth making-
Q74 Chair: We are talking about Vickers here, primarily, are we, or are we talking about Basel III?
Keith Skeoch: A combination of both. I think the UK is seen to be slightly more strident in its views and the timetable is seen as more stretching. It is noticeable that that has an impact on other UK banks, relative to their international comparators not just simply those with a certain danger.
Q75 Chair: So it is the whole sector?
Keith Skeoch: Yes.
Chair: It is not really a point directly on the UKFI point I asked, but it is useful to have anyway.
Q76 Mr Mudie: Just pushing a bit, the Chair did ask about UKFI. Where have you found a misguided tone from that organisation that sends the wrong message to the City and the market?
Keith Skeoch: I don’t think there was any-
Mr Mudie: No, but that was the question you answered with tone, and you gave it a different tone, and I find them incredibly independent of Government and this Committee, and I was wondering what they were saying to you that they are not saying to us.
Keith Skeoch: No. I was trying to make a different point, that simply creating greater independence for UKFI would not make a significant fix, in terms of the impact on the share price. Tenor and tone, and the view taken by Government and society on their attitude to the banks, as well as the issue about clarity, about regulation, those are two things that in order for a share price offer to be well taken and well understood, they are two foundations for improvement in sentiment.
Q77 Mr Mudie: So the general public have to stop whining, is that the tone? If you come north, and you see the unemployment and the depressed communities and the bad future and the houses being repossessed, they have a right to. So to sell RBS we should start speaking nicely about you?
Keith Skeoch: No, no, I think I am trying to make-
Q78 Mr Mudie: Don’t the banks in the City understand what the commercial banks have done to ordinary people in this country?
Keith Skeoch: As I said earlier, I believe the anger is understandable, but I think what we have, with the return of these stakes to the private sector, is a significant opportunity to suggest that the process of repair, and being able to look forward, is beginning. Certainly our attitude, as a long-term shareholder, is trying to be supportive of management.
Q79 Mr Mudie: I think we all understand that, but I think with the ordinary person-if I can class myself as an ordinary person, and I am-if there was any sign that the banking world accepted the blame, shared the blame, admitted to the blame and gave any indication to the British public that they had changed their ways, you might get a better press. Moving away from that, what key indicators would you want to see to indicate that RBS is ready for sale. There were two mentioned earlier: one was improved market conditions; the other was the removal of the DAS. Do you agree with those two and are there any others?
Keith Skeoch: I certainly agree with the removal of the DAS. Also, I think, to get an equitable treatment between A and B shares would be a technical issue, so that any cash flows are available either for dividends for investors, or indeed to be reinvested to create a return. From an investor perspective, the most critical thing is that we can see the prospect of an attractive return for our investors and savers.
Q80 Mr Mudie: Mr Talbut, the RBS that is going to be sold will be a different animal from the one before it was taken over. They have a different strategy and they are placing less importance on the investment side. Does that not militate against the Government getting back the price they paid for it because, to my mind, they are selling something that is much diminished, probably, in terms of profit?
Robert Talbut: We would take the view that the change in strategy, which has been implemented by the company, and is continuing to be implemented by the company, is entirely appropriate, given the new environment in which banks are operating, the new regulatory environment.
Q81 Mr Mudie: No, it may be appropriate, Mr Talbut, but does it affect the sale price in an adverse way?
Robert Talbut: I don’t necessarily think that it does, no. We have to judge the share price against the strategy that is now being implemented, without trying to take account of what the price was at some stage in the past.
Q82 Mr Mudie: Yes. What about you, Mr Buxton?
Richard Buxton: Patience is the key to rewarding investment, and I think you could get back to making a profit against the 41p if you are prepared to be very patient. I completely agree that, in the Royal Bank’s case, you have to restructure the capital base, the dividend access there, the A and B shares and so on. You have to get back to a situation where you can see the prospect of dividends if not dividends themselves. But, yes, doing it over time, doing it in tranches, your average exit price over many, many years could well be above 41p.
Q83 John Thurso: Can I start with you, Mr Buxton, and come back to the question of the structure of the balance sheet? We have already heard that the dividend access share is something of a deterrent. You also have the A, B structure. How important is it for the shares to become a commodity worth purchasing for the A, B share structure and the dividend access to be sorted out to or to be clarified?
Richard Buxton: It is important. I think Manus has written the definitive note explaining why you have ended up in a vicious circle rather than a virtuous one, and why, yes, the A shares will end up being diluted in some means by a restructure in the capital base, but in a way that then could accelerate the process of getting to dividend payments and returns of capital from the sales of, say, citizens down the line. I think it is really important in the Royal Bank’s case that that is addressed, whether it is alongside coming out of the asset protection scheme this year or not. Lloyds is clearly a different animal.
Q84 John Thurso: To you as a buyer of shares, an owner at the moment, how much of a barrier is it to you to the buying of further stakes? I put this to all of you. What I am trying to get a feel for is: are you saying, "What we would really like is, but we will buy them if it doesn’t happen" or, "Actually, guys, we are just not going to buy any more unless you sort this out"?
Richard Buxton: As I say, we already take into account the potential dilution from a future sorting out of the capital structure, but when shares are low enough, driven by sentiment, then we will continue to add to positions. In effect, though, you need to be asking the people who aren’t in this room because we are all holders and we are in the minority. It is the majority of institutional investors who won’t touch these things with a barge pole because of concern about double dip; lack of regulatory clarity; it can’t see a prospect of dividends and so on.
Q85 John Thurso: Would either of you like to add anything to that or is that pretty straightforward?
Robert Talbut: All I would add is that as shareholders we generally do not like investing in companies where there are differential positions between one shareholder and another. It does not make a company attractive.
Q86 John Thurso: So no investment in Facebook then?
Robert Talbut: Probably not. No.
Q87 John Thurso: Well done, you, by the way for that. Sorry, completely off piste there.
What about the asset protection scheme? To what extent is it vital that RBS needs to exit before any realistic tranche of share sale can take place?
Richard Buxton: In that the asset protection scheme was put in place to guard against tail risks from a massive economic downturn, you have to get them out of the asset protection scheme as part and parcel of the, "Well, it is strong enough to stand on its own now, even against a very difficult economic environment, in a major double dip recession". So it is important.
Robert Talbut: Yes, I think it is a significant signal to everybody outside that the company is emerging from the emergency ward.
Q88 John Thurso: So it is a core build of sentiment in the virtuous circle?
Robert Talbut: I think that is right, yes.
John Thurso: Okay. Thank you very much indeed.
Q89 Andrea Leadsom: Good morning. Jim O’Neil, who is Head of Market Investments at UKFI, has told us that, "If investors feel that the banks are not being run in a commercial way, then that would reduce their incentive to buy shares but also the price that they might pay for shares". Is it your view that RBS is being run in a commercial way, Mr Talbut?
Robert Talbut: I think it is being run not in an entirely commercial way. It is quite clear, through evidence over the last 12 months or so, that the company is still susceptible to being seen as a political football, when times get tough or when difficult decisions are being reached or when the company are attempting to make calls that could affect, say, employment or restructuring or the strategy of the group going forward, so I think that perception is there. I think it is a reasonable one. Within some of those constraints the management are trying to run it as best they can with a realisation that there are still going to be some constraints when there is a single shareholder who owns over 80% of the shares.
Q90 Andrea Leadsom: Mr Skeoch, would you agree?
Keith Skeoch: I would agree with most of that. I think management are trying to run the bank in a commercial way in the most extraordinarily difficult circumstances, both in political, and indeed-we find ourselves-in very strained economic circumstances as well. Their attempt to turn round their core book of business and the commercials is very commendable, and the progress they are making with the disposals of so called non-core assets acquired by previous managements is moving along quite nicely, given the underlying conditions.
Q91 Andrea Leadsom: Mr Buxton, would you say that it could be the non-commerciality of the way in which RBS is being run that reflects in the weaker share price?
Richard Buxton: No. I would agree with my colleagues that the entirely new senior management of the Royal Bank of Scotland, post-collapse, are doing a fantastic job of trying to manage the business back into a sensible shape and to generate returns on equity that will ultimately lead to dividends for shareholders. If we are tiptoeing around the elephant in the room of Hester’s bonus, that is clearly an issue that is one that became a political football. The man was invited to do this job. He is doing it extremely well. The bank is deleveraging. It is making progress, but there is a political sensitivity that means that at present he can’t be paid a commercial rate for that job.
Q92 Andrea Leadsom: Mr Talbut, would you say that Stephen Hester’s bonus has reduced investor confidence in the commerciality of RBS? What I am trying to get at is, do you think that in some way the Government ownership is acting as a drag on RBS share performance?
Robert Talbut: The simple answer to your last question is yes. The overhang or the presence of a single Government shareholder owning over 80% of the shares is an inhibiting factor on other commercial organisations wanting to own shares in the company.
Q93 Andrea Leadsom: Mr Skeoch, would you say that the row over Stephen Hester’s bonus has worsened that? In a sense, has that arguably meant that investor confidence in RBS has been damaged by the fact that there has been a public row over Stephen Hester’s bonus that has resulted in him not being able to take it?
Keith Skeoch: By and large that is correct, and I think it has had knock-on effects about the extent of debate and, as I said earlier, on the tenor and tone for sentiment. If you are looking to generate an attractive return, one of the things investors are trying to do in a very difficult world is look for things that they can attach some degree of certainty to. Anything that creates a degree of uncertainty, whether it is the regulatory framework or indeed the stability of a senior management team, inevitably increases uncertainty and depresses sentiment and, therefore, has a depressing impact on the share price.
Q94 Andrea Leadsom: That is a very interesting point. Mr Buxton, I was going to ask to what extent is it the fact that Stephen Hester did not get his bonus and therefore people might question his commitment, versus the fact that there is seen to be political involvement in the question over bonuses that leads people to think maybe there is political involvement in other issues to do with running the bank. Is it about the incentivisation of the individual to perform or is it about the political involvement that has a negative impact?
Chair: I have to ask you for a brief reply.
Richard Buxton: I think the two are completely interlinked, is a brief reply.
Q95 Andrea Leadsom: Mr Talbut, would you add to that?
Robert Talbut: Yes, I would agree with that. The only addition I would make is that I think the ability to retain a commercial management team, over the medium and longer term, is going to be significantly inhibited if they do not believe that they can be paid a commercial rate.
Andrea Leadsom: One question about Lloyds then, if I may.
Chair: If you can be very quick.
Q96 Andrea Leadsom: This is slightly off the sale of Lloyds. Do you think that it was right that Lloyds was allowed to choose which 600 branches it was going to sell or should those have been chosen for it, as is the case in other countries? In other words, do you think that the purchaser is going to find reasons to buy those branches or will they have been cherry-picked to be the worst?
Chair: If you want time to reflect on that question, take it and come back to us in writing, unless you have an answer now.
Keith Skeoch: I think it is appropriate because I think it is a decision for the board of Lloyds that we are all shareholders in. One of the things that connects it with the previous question is the ability of management to execute a board’s chosen strategy and, of course, the board are our representatives.
Chair: Anything anybody else wants quickly to add? No?
Q97 Mr Love: Mr Talbut, given all the challenges that you have spoken about so far, and the regulatory uncertainty, is there any realistic possibility that the Government will make a profit out of the sale of these shares?
Robert Talbut: My personal view on that one is that it is unlikely in the short to medium term. One of the abiding lessons that you are taught in investment, when you first enter the field, is that the price at which you sell a share should have no relation at all to the price at which you originally bought it, that is, you should not be hung up about the price that you bought into a particular investment. That you should always evaluate what the prospects are for a share at the point at which you decide either you are going to stick or you are going to twist. That would be exactly the same with Lloyds. For me, it is a case of not necessarily thinking about what the in price was, I am simply interested now in the prospect of appreciation of the share price from where we are today. But the simple answer is it is unlikely that the Government will see a profit in the foreseeable future.
Q98 Mr Love: Let me press you on that, because when the Government purchased these shares it was considered a depressed market. The share price had gone down considerably. There was almost an automatic assumption that when the share market conditions returned to something more approaching normal that the share price would go up. That doesn’t appear now to be what you are suggesting. Are we to take it that the restructuring issues, the ownership issue makes it not attractive to investors at the present time? What can we do, other than the issues that you have touched upon so far, to make these banks more attractive to the investor market?
Robert Talbut: If we could all hope for a much stronger fundamental economic background, I think that would help all banks, RBS and Lloyds certainly. The prospects economically have turned out to be much more subdued than was envisaged was going to be the case at the time at which the stakes were bought, so I think there was an expectation the economy would bounce back quite strongly, asset prices would bounce back quite strongly, and therefore there was a prospect of some form of return on the entry. I think economic prospects have been far worse. The uncertainties about the regulatory outlook are more significant, and therefore the prospects are much more diminished in terms of us being able to achieve a return.
Q99 Mr Love: Mr Buxton, you wanted to respond but I will add a question to your response. Do we need to wait for a return to a level of profitability that will make an investor market more interested in paying what would be a profitable price for the shares?
Richard Buxton: In the short term, you are not going to make a profit, but I am a bit more optimistic that on a five-year view you will be able to make a profit. As I say, on average over a series of tranches you can make a profit because, accepting that the world has changed, the regulatory background has very much changed from the entry price. Nevertheless, provided these banks can get back to making a genuine return on equity above their cost of capital and with a capital base that is more secure and with an ability to pay dividends, you will be able to exit these banks I think at a profit, over time.
The steps-in terms of getting back to profitability-I think they are making good progress on that. It is different with Lloyds and Royal Bank. Royal Bank has probably made more progress in terms of reducing the size of its balance sheet and taking greater losses. It is less susceptible to a significant double dip than Lloyds. Lloyds are more susceptible to that, but they have made substantial progress on bad debt write-offs. In both cases, the formation of new non-performing loans has fallen away to very low levels, but there is still a large outstanding stock of non-performing loans, so patience is a tremendous virtue here. You only have to look out to 2013, 2014, if the pace of deleveraging and taking losses continues at the current rate then you could get back to something that is making an attractive return on equity and where investors will be much more interested in investing.
Q100 Mr Love: Mr Skeoch, RBS have a five year plan-I think it is-to divest some of the assets that they had taken on prior to the credit crunch. There is the return to profitability that we have talked about that may take some considerable time. Is there a consensus among the three of you about how long the foreseeable future is, how long we have to be patient before we begin to realise the sorts of level of share sale price that would return a profit?
Keith Skeoch: There are two questions there. I think the precise timing of when the prospect of a profit comes into visibility is exceptionally difficult, because it will depend on market conditions at the time. I agree with Mr Buxton that patience would be a great virtue and, if you can look out on a time horizon of five years plus, there is every chance that there will not only be a profit made but the prospect of a substantial and attractive return for the Exchequer and the taxpayer, certainly one that is much more attractive than today.
Q101 Mr Love: Are we talking about significantly in excess of five years before we would be looking at the foreseeable future, if the Government decided that it had to realise at least not a loss on the sale of these shares?
Richard Buxton: I think five years is appropriate.
Q102 Mr Love: Five years is appropriate, you wouldn’t disagree with that. Can I just ask finally-
Chair: A brief reply, please.
Mr Love: The share price is currently stuck around 30p. There is a very small market in RBS shares particularly. Are they connected in any way, and is the share price depressed for other reasons than the ones that we have talked about this morning?
Richard Buxton: No, I don’t think there is a fear of a small share price in an absolute sense and there is hundreds of millions of Royal Bank turnover every day, but it is all the issues that have been discussed already. It is regulatory backdrop. It is ensuring there is no major double dip and that, therefore, progress is being made on profitability. In Royal Bank’s case, it is the capital structure.
Chair: Anything others want to add to that list that has not already been added?
Robert Talbut: No.
Q103 Mr McFadden: There has been a slight difference in emphasis in your evidence compared with our first session this morning. I just want to explore this issue of price and timing. The Abu Dhabi sovereign wealth fund was recently reported as having expressed interest in taking out a sizeable stake in the bank. In answer to Mr Love, you were talking about five years being a reasonable timescale. How then would you view an early sale of a significant stake in the bank to a sovereign wealth fund like that? Would that be important, in terms of establishing confidence that big private sector investors were prepared to step into this field, or does that look like an unwise thing to do, because it would be sold significantly below the entry price that the taxpayer paid? I will start with you, Mr Buxton.
Richard Buxton: A sovereign wealth fund might have a role to play if there was the pursuit of-in particular, in Royal Bank’s case-this change in the capital structure, and perhaps they had an appetite for an instrument like a convertible security that the conventional marketplace isn’t yet ready to take. A sale of straight equity to a sovereign wealth fund, I would personally be disappointed to see because I suspect they would just be in it to make a lot of money for themselves.
Q104 Mr McFadden: Isn’t that what any investor is doing?
Richard Buxton: Absolutely. As I say, if you are prepared to be patient you don’t need to give the Exchequer’s money to a sovereign wealth fund, you can actually retain it over time and make that money back.
Q105 Mr McFadden: Can you just explain to the Committee-forgive my ignorance-this issue about convertible security, exactly what that is and why that comes into play more than a sovereign wealth fund in-
Richard Buxton: Yes. CoCo is convertible securities contingent capital. It is something for which as yet there is not really a fully developed market among institutional investors, let alone retail investors. However, some sovereign wealth funds are prepared to commit to that type of capital, which could form a part of the restructuring of the A and B shares, the dividend access scheme and so on. They may have a unique role to play in taking a part of a capital structure that the conventional bond or equity markets are not keen to pursue as yet because it is a fairly new market.
Q106 Mr McFadden: Mr Talbut, what do you think of this idea of a sovereign wealth fund?
Robert Talbut: I would probably take a slightly nuanced different view from Richard. We would be unhappy if a single investor were to be invested in at preferential terms to other shareholders. If that were to be part of a sale that was wider than a single investor, that might be seen as interesting, in terms of attracting in another private sector organisation. But in terms of some form of sweetheart deal, we would find that very unattractive and we wouldn’t see that as being in the best interests of investors generally, or the company.
Keith Skeoch: I take a slightly different approach, given the strained circumstances they find themselves in. Providing, first, the sale was of Government B shares rather than the issue of new stock; and, secondly, that it was associated in some way with the removal of the dividend scheme, or removal from the APS, it could be seen as helpful. Most importantly, however, is that there was a commitment that the strategic investor was going to be a long- term holder; strategic and long-term as opposed to a large holder, and I think the two are very, very different indeed. If it is perceived to be a long-term value play, it could be helpful in setting the ball rolling.
Q107 Mr McFadden: I want to clarify the view on this, which Mr Mudie referred to earlier. The Government bought these shares, on behalf of our constituents, at an average price of about 50p. It has never approached that price since and they are trading significantly below that. As a current investor and potentially a bigger investor, is it your view that we would be better to sit tight and wait for RBS to continue with the path of change that it is taking to get back to that price, so that our constituents get their money back or, because of the capital structure, which we have heard about today, these shares, the dividend access shares and so on, the deal with a sovereign wealth fund to get rid of these obstacles might actually be worth doing now?
Keith Skeoch: It depends on the initial price. I must say, as a long term investor, my natural disposition is-as Richard Buxton said-to be patient and make sure that full value accrues for the scale of the investment that was put in place. Given the strained circumstances, providing it was seen as kick-start, and also it was an investor that would support a commercial board and a commercial executive, it might be a good way of getting things moving. It would depend on the circumstances.
Q108 Mr McFadden: Finally, Mr Talbut and Mr Buxton, I am taking your initial answers as saying you are in a bit of a different position on that, and that you are more in the hope that the taxpayer should sit it out and wait for Stephen Hester and his team to get the bank back into shape?
Richard Buxton: I think that would be preferable. There is an element in which, perhaps specifically in Royal Bank’s case, through an instrument that could form part of the capital restructuring, a sovereign wealth fund might be appropriate. I completely endorse Keith’s point: it has to be long term and strategic. One is mindful of the fact that the sovereign wealth fund that supported Barclays capital-raising claimed it was going to be long term and supportive, and sold it very swiftly at a profit. Your constituents would learn about that: I as a taxpayer don’t want to read a headline saying, "Sovereign wealth bought a big stake at 25p and sold it five years later at 50p", when if we had sat there and been patient we could have sold it at 50p.
Robert Talbut: Very briefly, my view is that I believe, yes, very firmly in the idea of patience. I believe we are looking at something like five years in terms of rehabilitation, but I don’t necessarily think that it means five years before any stock could be sold into the marketplace, into the private market.
Q109 Mr Ruffley: Just one question for each of you to answer; the same question. In the highways and byways of Westminster, there is speculation that RBS might be broken up prior to any sale, and the reason that might be a good idea is to engender greater competition. These are very ill-formed speculations. Could I just ask each of you, as market players, whether you have heard of anything that sounds viable in terms of breaking up RBS prior to a share sale?
Richard Buxton: It has already been broken up by the EU, in terms of forced disposals of-
Mr Ruffley: No. Over and beyond what we already know.
Richard Buxton: I think we need to wait and see the conclusion of the Verde Lloyds disposal first, because that genuinely tests the appetite for the creation of separate or bigger banking entities and greater competition. I am not hearing rumours or discussions of any magnitude about this, but I think it would be detrimental to the taxpayer to enforce any break up. As the investment banker said-about the only thing I agreed with him on-demergers are very complicated and they do not always add value. You are replicating head offices and HR functions and so on, which is why banks tend to consolidate and merge. I think the best value for the taxpayer will be allowing Hester and the team to manage the existing business. Of course, in the fullness of time, it is highly likely they will sell their US business but the longer we leave it the better price we will get, et cetera.
Robert Talbut: I have a lot of sympathy with that view, but I think continuing speculation about further break-up of the company is unhelpful in terms of the share price, and is unhelpful in terms of the management’s ability to be able to commercially run the organisation.
Q110 Mr Ruffley: I understand that. It is clear what the detriment might be from the taxpayer’s point of view, but in terms of challenger banks, more competition, driving down prices for the consumer, in terms of the propositions you have heard of further break-up, is it just mere speculation or do you actually have in your mind, or have you been told, what a further break-up of RBS might entail?
Richard Buxton: Northern Rock was a challenger bank, HBOS was a challenger bank. There is no evidence that challenger banks end up being better managed and being good for the consumer. They helped get us into this mess.
Robert Talbut: The only other point I would make is simply that I am unconvinced that there is a plethora of other organisations out there desperate to get into the UK retail market.
Keith Skeoch: I am not aware of anything, and I certainly haven’t come across anything that I would believe was in any way credible.
Q111 Mark Garnier: Getting back to the Portman Capital suggestion of essentially distributing shares with a face price, which I am sure you are familiar with. Robert Peston has said that his guess is that the City establishment will view the Portman Capital proposal to distribute shares in RBS and Lloyds to the taxpayer as "naive and impractical". Do any of you agree with that? Free money for the taxpayer, what do you think? Do they not understand it?
Richard Buxton: I don’t know about naive. Whether it is impractical or incredibly complicated and quite expensive, I think it is certainly those.
Chair: It is quite bad.
Q112 Mark Garnier: On the subject of fees, I don’t know if you were at the evidence session a bit earlier, but it was obviously the sell side of the marketplace, they were saying the fees would be 50 basis points across the piece for any sort of distribution or transaction. In your experience on the buying side what do you usually expect to be paid for underwriting of an issue?
Richard Buxton: We are very happy to take significantly lower underwriting fees than very often the investment banks claim that we-
Q113 Mark Garnier: They are taking their slice, aren’t they? You are not getting the whole of it, you are just sub-underwriting them, but you are taking all the risk and they are sucking out some of that fee, aren’t they?
Richard Buxton: Yes. But, as I say, the aggregate fee, the bit that they sub to us, is higher than it need be because we would take less, particularly for an existing shareholding organisation.
Q114 Mark Garnier: What would you do, though-privatisation-what would you expect to be paid for underwriting, as a sub-underwriter?
Richard Buxton: I am not going to give a figure, but I am going to say-
Mark Garnier: Go on, be a devil.
Richard Buxton: No, I am not. But I am going to say that there have been two reports, both the Vickers report and the report into underwriting practices, which have concluded that this is not a competitive market.
Mark Garnier: Yes, that is right.
Richard Buxton: But we are not going to do anything about it-
Q115 Chair: Maybe it is time we took a look at these wholesale markets, don’t you think?
Richard Buxton: Yes, because it is up to us, as institutional shareholders, to force companies to bid down the price. We spend our time constantly trying to get companies to bid down the price of the investment banking underwriting fees, et al, and they say, "Well, actually, we only ever do one capital raising as a chief executive or finance director, and so frankly it is not our money. It is the shareholders’ money. We want the deal to go ahead". We bang our heads against a brick wall trying to get investment banking fees and underwriting fees down. However, there have been transactions in the last three years, where the institutional investors have played a more active role earlier in the process and been quite prepared to take a much lower level of underwriting fee and, funnily enough, the investment banks aren’t wild about it.
Q116 Mark Garnier: Do you think if this transaction were to go ahead in one form or another, it would be one where the investment community would be quite strong and unified in terms of driving down those underwriting fees?
Richard Buxton: If all the stars have aligned in the way that we have talked for the past two hours, then yes.
Q117 Mark Garnier: Do you all agree with that?
Keith Skeoch: Yes.
Robert Talbut: Yes. I would agree with that, certainly. There would be plenty of opportunity for a lot of communication between the company and prospective shareholders, and I am sure we could reach a very amicable arrangement.
Q118 Mark Garnier: Cut out the middle man so they would not get a lead underwriting fee?
Richard Buxton: Cut the middle man amounts down to as thin an amount as possible.
Robert Talbut: Which is commensurate with the task they actually do.
Keith Skeoch: Yes, so maximum transparency and clarity.
Mark Garnier: So one basis point maximum, maybe. Message received and understood.
Chair: We will come back to you for some more advice on how to get these markets more competitive, yes, and we would want the advice to be free, as Michael has pointed out. Thank you very much for coming to give evidence today. It has been extremely helpful to us and we really appreciate it, as we did the first panel.