Celebrations for Ulster Bank reprieve could be premature

The UK treasury report on the Royal Bank of Scotland (RBS) is largely a damp squib. Nevertheless, it contains an important statement on the bank's Irish operation – Ulster Bank – and this could have significant implications.

As an unwilling 81 per cent shareholder in RBS, the UK government was keen to sell its stake in the bank. During the past few months it has considered splitting RBS into a "good" bank that could be sold and a taxpayer-funded "bad" bank that might be retained by the government.

A further concern is that the UK government would like RBS to increase its lending to UK businesses and households. Ulster Bank is (and will be) a drag on RBS’s profitability, hence it was a candidate for inclusion in the “bad” bank.

Kites were even flown in June of this year, suggesting that Ulster Bank might be transferred to the Irish State.

Yesterday, the UK treasury reported on its deliberations. It has determined that RBS will not be split into independent “good” and “bad” banks. Clearly the analysis benefited from the Nama experience in the Republic as it was apparent that separating good and bad banks is easier said than done.

Internal distinction
Rather, the bank will now distinguish internally between its "good" and "bad" components. The bank will then disclose the results of these operations separately. This will allow potential investors to distinguish more clearly the management of the bad loans and will allow RBS crystallise a large loss on these assets in the current financial year.

So it appears little will change except the manner in which RBS describes its results to external parties.

British chancellor of the exchequer George Osborne has admitted that the reprivatisation of RBS is “unlikely before the [2015] general election”. RBS will not be split into independent “good” and “bad” entities. Rather, it will rearrange its loan book internally and book a significant accounting loss in 2013.

For Ireland, it appears Ulster Bank has obtained a reprieve – though paragraph 1.31 of the treasury report states: “Ulster’s cost base will need substantial restructuring if the bank is to remain attractive. Its cost-to-income ratio was 61 per cent in the first half of 2013 and would have been higher still if the income from the circa £9 billion of loans being transferred to the internal bad bank had not been written in the first place.”

On foot of these observations, the treasury requires a comprehensive review of Ulster Bank, for completion within six months.

These comments suggest any welcomes for the Ulster Bank reprieve – on both sides of the Border – were premature.

To me, the agenda is clear. In order to prepare RBS for reprivatisation, a substantial restructuring of Ulster Bank must occur. While the good bank/bad bank is simply an internal rearrangement, at the level of Ulster Bank it will result in a significantly higher cost/income ratio.

There is likely to be considerable pressure to realign Ulster Bank's cost base in the Republic.

Greater visibility
The UK treasury's rejection of a taxpayer-funded bad bank for RBS will result in postponing the reprivatisation of RBS. In choosing to realign the loan books internally, the main consequence is greater visibility of the underlying profitability of the Irish business.

For the Irish business, the key milestone will be the comprehensive review due
for publication by next February. Until that becomes available it would be premature to celebrate a reprieve
for Ulster Bank, especially in the Republic.

Eamonn Walsh is PwC professor of accounting at the UCD Michael Smurfit Graduate Business School