Challenge facing RBS will not be easy to solve

A report by stockbroker Davy yesterday captured the challenge facing Royal Bank of Scotland to find a solution for its Ulster Bank subsidiary in the Republic.

Ulster Bank returned to the black in the first quarter of this year with a £17 million surplus but a question mark hangs over the business in the Republic, which is under review by RBS.

Having pumped £15 billion into Ulster Bank since the crash in late 2008, the Scottish financial institution has decided that the business in the North should forge closer ties with RBS in Britain while a strategic partner should be sought for the business down South.

Coincidentally, the report was published on the day Ulster Bank informed staff of its plan to close 15 branches and sub-offices across the island. This will have the effect of reducing its number of locations to 199 and is the first stage of a planned process of bring the number down to somewhere between 175 and 185.

Ulster Bank is also in a consultative process with staff and their unions on other restructuring measures as it seeks to trim its cost base – its cost/income ratio was a chunky 69 per cent in the first quarter.

Finding a solution for the business in the Republic won't be easy. Morgan Stanley is on the case and the narrative is that Ulster will either merge with Permanent TSB or KBC Bank Ireland, or will receive an injection of cash from a private equity player, with Warburg Pincus and KKR mentioned among possible suitors.

Third banking force

It could be a combination of both, possibly as part of a third banking force that could have backing from the State.

However, Belgian bank KBC has made it clear that it intends to go its own way in Ireland until the subsidiary here is back in profit in 2016. And merging Ulster Bank with Permo is easier said than done. As Davy highlights, Ulster has a loan-to-deposits ratio of 132 per cent while Permo’s is 131 per cent, if you exclude its UK book, which is to be sold off. The case for merging two over-leveraged banks, with large mortgage tracker loan books in distress, is not exactly compelling.

The Ulster Bank business in the Republic comprises a loan book of £10-£15 billion, excluding its £10 billion in loss-making trackers. Davy notes the high cost/income ratio and an internal estimation of a very low return on equity over the medium to longer term if the business is not reshaped. A 20 per cent market share across product lines is deemed “desirable” but Ulster’s share is below this – 11 per cent for current accounts and deposits, 16 per cent for SME lending and 17 per cent for mortgages.

On the flip side, the net interest margin has rebounded and the bad debt charge has declined. Chief executive Jim Brown and his team have worked hard to get on top of its mortgage arrears, with some positive results.

There is some upside potential, which always appeals to private equity, especially if you buy into the Irish recovery story. Mortgage arrears have peaked, employment is growing and the property prices are rising. Ireland needs a challenger bank to AIB and Bank of Ireland.

Risky punt

Nonetheless, it’s a risky punt and you can be sure a private equity buyer would extract a high price from RBS for any cash injection into Ulster Bank.

RBS will publish half-year results on August 1st. The likelihood is that there will be little by way of update to its strategic plans for Ulster Bank in the Republic. We’ll probably have to wait until its third quarter update on October 31st for signals as to where the process is heading. Hopefully, it won’t drag on beyond that date.

The last thing staff, customers or the Irish economy need is a long, drawn-out process that sees Ulster Bank simply marking time.