Is there any chance for Royal Bank of Scotland (NYSE: RBS ) to become a healthy business again? It's looking doubtful at the moment, especially considering that Spanish banking group Santander (NYSE: SAN ) has just pulled out of a long-boiling plan to buy 316 of its U.K. branches for 1.65 billion pounds ($2.7 billion). If completed, the deal would have provided much-needed funds for the suffering British bank and helped it consolidate its operations. Alas, it was not to be, and I think the bank should be given a wide berth by investors.
Divest or else
For RBS, the sale wasn't an option. It was one of the requirements handed down by the European Commission for being bailed out by the U.K. government several years ago. Like many big banks around the world, it was hit hard by the financial crisis of 2008.
The crisis nearly wiped it out, and it wouldn't exist today if it weren't for the rescue mission launched by its government. The state handed the bank 45.5 billion pounds ($73 billion) in public money in return for effectively nationalizing the company. It's now far and away the bank's largest shareholder, owning around 83% of its stock, and that might not be the end of it. Whispers in the halls of power say that the government is considering buying out the remainder so it can force it to start lending more to domestic businesses in a bid to help the economy.
RBS looks like it's in poor shape to do so, however. In 2011, net interest income declined for the third year in a row. The 12.7 billion pounds ($20 billion) it took in was only around two-thirds the figure posted in the nationalization year of 2008. In fact, that metric has been negative in two of the past four quarters for the bank. It nearly goes without saying that it hasn't netted a profit in any fiscal year since before the crisis.
It's not for want of trying. In an effort to save some -- any -- money, the bank has given the chop to thousands of employees since the crisis. On a more positive note, it just finished floating 30% of Direct Line, its insurance business, for a pretty 787 million pounds ($1.3 billion)... although, like the branch sell-off, this was mandated by European authorities as a condition of being rescued/nationalized. RBS has also successfully divested much of its former investment banking operations like, for example, unloading classic British white-shoe broker Hoare Govett to Jefferies Group (NYSE: JEF ) earlier this year.
Cold feet
Given its ability to unload assets into an unenthusiastic, hesitant market for European banking assets, RBS must have been surprised to get word from Santander that the Spanish company no longer wanted the branch network. Britain is hardly motoring ahead economically these days, but it's in better shape than Europe's laggards (like, well, Spain). Plus, considering the difficulties in its home market of Spain, Santander is doing rather well. For example it managed to grow net interest income by 8% year over year in 1H 2012; that compares very well to, say, the 11% drop experienced this past quarter by Bank of America (NYSE: BAC ) , a major financial that still has plenty of Europe exposure.
At first, Santander said it pulled out of the deal because of the delay in completing it (originally, it was announced in the olden days of August 2010, but there was time; the European Commission required the sale to close by the end of 2013). The real reason might be trouble at home; while Santander is well diversified across many global markets and derives much of its revenue and profits abroad, it still has a heavy foot in Spain. This is typical for Spanish banking majors; Santander's domestic rival BBVA (NYSE: BBVA ) has a similar profile.
Spain's financial crisis seems to be deepening, if anything, and expectations are that regulators will crank up the pressure for domestic banks to shore up capital. It's understandable that Santander would be eager to keep the RBS branch money for that increasingly likely rainy day.
Who's next?
The 316 branches constitute an attractive asset for any ambitious financial aiming to expand their U.K. network -- as Santander planned to do -- or enter it as a new player. The branches serve around 1.8 million customers and have almost 22 billion pounds ($35 billion) in deposits. Uncharacteristically for RBS, they also make money, posting an operating profit of 186 million ($299 million) in the first six months of this year.
And according to a report from the BBC, there are already two potential buyers now that Santander has walked away from, although the news service didn't name who they are.
Regardless, although the branch network might be a good purchase and RBS an eager and effective seller, the abandonment of an important potential buyer isn't a good development. Assuming at least one those two suitors, whoever they are, makes an approach it'll probably start bargaining for the thing at a well discounted price and eventually get a sweet deal.
That doesn't bode well for the future of RBS, nor does its potential for complete nationalization or its continuing operational woes. Any bank that's busier and more successful unloading assets and going hat in hand to its government than growing its core business is one to stay away from. For the moment, at least -- until the ship is righted and the bank starts sailing again. But that's far from certain to happen with RBS.
For a bank with better potential despite its post-crisis struggles, check out our in-depth company report on Bank of America. The report details Bank of America’s prospects, including three reasons to buy and three reasons to sell. Just click here to get access.
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