DBRS Places RBSG “A” Rating Under Review With Negative Implications

DBRS Ratings Limited (DBRS) has today placed the long and short-term ratings of the Royal Bank of Scotland Group (the Group or RBS), including the A (high) long-term rating of Royal Bank of Scotland plc and A rating of the Group, under review with negative implications. This rating action follows DBRS’s announcement that it has removed the rating floor for critically important banking organisations (CIBs) in the UK (see “DBRS Removes UK Rating Floor”, published July 15 2013 for further details). The review of RBS’s ratings will assess the impact of the removal of the rating floor, as well as taking into account the uncertainty over the future structure of the Group and any negative impact on bondholders that could result from a break-up of RBS.

DBRS removed the UK’s A (high) rating floor on July 15 following an assessment of the applicability of the rating floor for CIBs in the UK. The senior debt and deposit ratings of RBS have incorporated two notches of uplift from the Intrinsic Assessment (positioned at A (low) at the Royal Bank of Scotland plc, the main operating bank), with one notch of this uplift resulting from the application of the rating floor. Following the removal of the rating floor, the review will consider whether the ratings of RBS should continue to benefit from this higher level of support.

DBRS will also assess any negative impact on bondholders that could result from the government’s forthcoming review of the case for splitting RBS into a “good bank” and a “bad bank” that would contain the more risky assets. In June 2013 the UK Chancellor responded to the report of the Parliamentary Commission on Banking Standards by stating the government’s intention to conduct such a review with a decision to be made in the autumn of 2013. DBRS expects to conclude its review of the ratings upon the government’s completion of its review of RBS’s future structure.

DBRS recognises the Group has made steady progress over the past 4 - 5 years in strengthening and cleaning up the balance sheet. Non-core assets have been reduced to GBP 53 billion at the end of 1Q2013 (compared to GBP 94 billion at the end of 2011 and GBP 258 billion in 2008), funding and liquidity is strong relative to peers, and although capital remains a challenging issue for RBS and other large UK banks, RBS has cleared the UK regulator’s recent capital shortfall exercise with no requirement for significant actions beyond the Group’s existing plans.

However, the politicisation of RBS, which remains 81% government owned, as well as the ongoing losses and significant regulatory and conduct charges it has reported, have made it difficult for the bank to complete its turnaround and have exacerbated the uncertainty over its future. The UK authorities want RBS to focus on UK retail and corporate lending, but at this point it is not clear how they will try to achieve this, and what the implications could be for bondholders.

RBS plc’s A (low) Intrinsic Assessment (IA) has incorporated DBRS’s view that the Bank has a number of fundamentally strong business lines, particularly the retail and commercial banking franchise in the UK. However, there is also uncertainty about the future structure of the Group. The US retail and commercial banking subsidiary, RBS Citizens (Citizens), has a robust market position, but the recent announcement to partially float Citizens has opened up the question as to how long it will remain part of the Group. In addition, although RBS views its restructuring of its Markets business as a way of right-sizing the business to the needs of its core UK corporate client base, there is a risk that the franchise will be undermined by continual restructuring. The Group’s Irish operations, Ulster, remain loss-making and are still in a recovery phase, and the Group still needs to complete the sale of 315 branches to meet EC State Aid rules, following the collapse of the sale to Santander in 2012.

At this stage it is difficult to assess what course of action the government may pursue following its review, given the significant legal, logistic and regulatory hurdles surrounding any further restructuring of RBS. However, DBRS considers there is a high likelihood that a restructuring would be negative for bondholders, given the government’s commitment to bailing-in creditors in bank restructurings.

Separately DBRS confirms at BB (low) the ratings of the preference shares issued by RBS Capital Funding Trust V/VI/VII, which had halted dividend payments from 2011 in line with EC restrictions on RBS as a recipient of State Aid, and notes they have resumed payments from 30 June 2013. DBRS rated these instruments one notch below our standard notching policy to reflect the added risk from non-payment. DBRS expects to move the ratings of these instruments back in line with our standard notching, once the review of the Group’s ratings has been completed.

Notes:
All figures are in British Pounds (GBP) unless otherwise noted.

The principal applicable methodology is the Global Methodology for Rating Banks and Banking Organizations. Other applicable methodologies used include the DBRS Criteria – Intrinsic and Support Assessments; DBRS Criteria: Rating Bank Subordinated Debt and Hybrid Instruments with Discretionary Payments and DBRS Criteria: Rating Bank Preferred Shares & Equivalent Hybrids. These can be found at: http://www.dbrs.com/about/methodologies

[Amended on July 30, 2014, to reflect actual methodologies used.]

The sources of information used for this rating include company documents and SNL Financial. DBRS considers the information available to it for the purposes of providing this rating was of satisfactory quality.

Lead Analyst: Elisabeth Rudman
Rating Committee Chair: Alan G. Reid
Initial Rating Date: 27 October 2004
Most Recent Rating Update: 5 July 2012

For further information on DBRS’ historic default rates published by the European Securities and Markets Administration (“ESMA”) in a central repository see http://cerep.esma.europa.eu/cerep-web/

Generally, the conditions that lead to the assignment of a Negative or Positive Trend are resolved within a twelve month period while reviews are generally resolved within 90 days. DBRS’s trends and ratings are under constant surveillance.

For additional information on this rating, please refer to the linking document under Related Research.