On July 5th the 4th of July fireworks celebration ended with a BIG bang when Moody’s Investor Service (MCO) placed Royal Bank of Scotland plc’s (RBS) on review for a downgrade. According to the public statement made by Moody’s:
London, 05 July 2013 — Moody’s Investors Service has today placed on review for downgrade Royal Bank of Scotland plc’s (RBS) D+ standalone bank financial strength rating (equivalent to a baa3 baseline credit assessment), its A3 long-term debt and deposit ratings and the bank’s subordinated debt and junior capital instruments. The firm’s Prime-2 short-term ratings were affirmed. The long-term ratings of the holding company, Royal Bank of Scotland Group plc, were also placed on review for downgrade.
Concurrently, Moody’s has placed on review for downgrade the standalone credit assessments and all other long-term ratings of National Westminster Bank (Natwest) plc and Royal Bank of Scotland NV. These ratings are aligned with those of RBS given the high degree of integration between RBS and these two entities.
Moody’s action reflects the further uncertainty for bond holders resulting from the UK government’s recent announcement that it is examining the merit of a possible breakup of RBS and how this could be achieved. Moody’s understands that the government will consider a range of options for removing higher risk and/or impaired assets from RBS, and the ratings agency believes that some of these options may entail losses for creditors. The heightened level of uncertainty is likely to remain at least until the publication of the government’s conclusion from its assessment, after which Moody’s expects to conclude its ratings review.
Source: Moody’s
The situation in Europe is worsening and this publication is but one one example of a global financial crisis that has not come close to running its course. Unlike the U.S. Government, however, the governing bodies in Britain are less willing to support, in perpetuity, their banking institutions with taxpayer monies. Though, at this point in time, Moody’s sees the risks to RBS creditors as “low,” losses to RBS bondholders remains a very real risk, indeed, given that the UK has not employed (and, most likely, will not employ) the same Quantitative Easing (QE) techniques (i.e. support for the banks to the nth degree) that have been employed by the U.S. Federal Reserve.
The review for downgrade of RBS’s ratings follows the announcement by the UK Chancellor of the Exchequer on 19 June of the commencement of a cost-benefit review to evaluate the merit of breaking up RBS in order to achieve the government’s goals of (1) promoting economic growth; (2) maximizing value for taxpayers; and (3) accelerating RBS’s return to the private sector. This course of action is in line with the recommendations of the UK Parliamentary Commission on Banking Standards published on the same day, and indicates that the political debate about the strategy for RBS is still very open, with a number of options under consideration.
In Moody’s view, the probability of losses to RBS creditors remains low. However, there is potential for further capital impairment and the government has clearly indicated that it will not put additional taxpayer capital into RBS. As such, the government could consider options that might result in a higher risk of loss to bondholders, particularly junior bondholders, than is currently reflected in RBS’s senior and subordinated ratings. The decision to affirm the short-term ratings reflects Moody’s current view that a downgrade of the senior ratings of more than one or two notches is unlikely, especially given that burden sharing with creditors may be deemed to be in conflict with the above-stated Government objectives.
For example, the accelerated sale of assets, together with the crystallisation of losses could imply a faster erosion of capital than RBS can sustain. Alternatively, a full legal split of RBS, while being costly, complex and disruptive to management, would also have a negative impact on the Group’s profitability, could pose a strain on its liquidity and might also result in a capital shortfall depending on the valuation of assets moved to the Bad Bank. Any of these options could therefore have credit negative implications for bondholders. At the same time, Moody’s recognises that upon completion, the separation could bring long-term benefits to RBS’s financial position, with credit-positive implications for creditors of its post-transition going-concern operations.
Moody’s expects to conclude this ratings review following the completion of the government study on the merit of the breakup and the announcement of the decision on the future of RBS. The government has indicated that an announcement in this respect will be made in autumn.
Source: Moody’s
Disclosure: I do not own shares of RBS but I do own one of the bank’s bonds.
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