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Hester faces three-year grind to finish RBS turnaround

Royal Bank of Scotland (RBS) Chief Executive Stephen Hester speaks to media as he leaves after appearing at a Treasury Select Committee hear
Royal Bank of Scotland (RBS) Chief Executive Stephen Hester speaks to media as he leaves after appearing at a Treasury Select Committee hear

By Matt Scuffham

LONDON (Reuters) - For Royal Bank of Scotland Chief Executive Stephen Hester, the biggest turnaround in corporate history is not over.

Hester, who has shrunk RBS by 700 billion pounds ($1.1 trillion) since he began repairing its balance sheet four years ago, can count on at least three years' work to finish the job.

At the height of the 2008 financial crisis, RBS came within hours of running out of cash, and Britain had to pump in 45.5 billion pounds to prevent a potentially catastrophic failure of what at the time was the world's fifth largest bank.

With British taxpayers left holding an 81 percent stake in RBS, which had a meteoric rise thanks to a string of takeovers, Hester's challenge has been to return the once small Scottish retail bank to being a "normal" lender, with loans matched by its deposits instead of a reliance on wholesale funding.

Past mistakes still haunt RBS. The bleakest clouds on the bank's near horizon are impending punishments - likely to be fines - for its part in the manipulation of the London interbank offered rate (Libor) and other key interest rates.

Hester, who is used to media criticism, is braced for public opprobrium and wants to agree Libor settlements before publication of RBS's full-year results in February. He has warned of a "miserable day" when the penalties are meted out.

Regulators are examining evidence of wrongdoing by RBS traders up until 2010, a period well into Hester's tenure.

However, unlike Barclays, which lost its chief executive, chairman and chief operating officer in the fallout from the affair, the probe into RBS is not expected to compromise senior figures, according to industry sources.

More than a dozen banks are currently under investigation in a global interest rate rigging probe. Barclays was the first to settle, paying 290 million pounds ($466 million) in fines in June, and some analysts believe RBS will face a worse penalty because Barclays was granted leniency for settling early.

PAYING DIVIDENDS

If Hester can put the Libor affair behind him, his focus will switch to ensuring RBS restores dividend payments, a key milestone towards selling off the government's stake.

To get to that point RBS would need to be cleared to escape the state's first call on any payouts. That would require approval from the European Commission under state aid laws and assumes a green light to pay dividends from UK regulators.

"I would imagine they are already in talks to restore the dividend, which really is the last piece in the jigsaw," an investor ranking among the top 10 holders of RBS shares said.

However, with the Bank of England saying last month that UK banks needed to act now to bolster their defenses against financial shocks, that may not be before late 2014.

"People's expectations of dividends generally in the banking sector in the UK have moved back," one industry source said.

RBS is also facing pressure from the Financial Services Authority to sell its U.S. business, Citizens, in order to bolster its capital or further shrink its investment bank.

Hester has said Citizens may be sold, though he would prefer it did not happen now as, in the current environment, he believes it would not command a price that would meet the rationale for a sale.

RBS has held informal talks with some interested parties, industry sources have told Reuters, and the bank faces a delicate balancing act in keeping would-be buyers interested while not destabilizing the business.

Retaining Citizens also gives RBS a 'get out of jail card' if it were to be required to raise capital quickly in the event of a worsening of the euro zone crisis, the sources said.

An alternative means of appeasing regulators would be for RBS to further shrink its investment bank. However, having already shrunk the business so that it accounts for around 20 percent of operating profit compared with about half in 2007, it is reluctant to slim it down further.

PRIVATISATION PLAN

Having engineered an exit from a costly government insurance scheme and the sale of shares in its insurance business, Direct Line , the end game for Hester is returning RBS to private ownership.

RBS Chairman Philip Hampton said last month it was preparing for the British government to start selling shares in the bank before the next election in 2015.

RBS has indicated a share sell-off would need to be in four tranches over a period of about 10 years. However, such a plan would require the government to accept a loss on the first sale in order to get much-needed liquidity for the bank's shares.

The shares closed on Friday at 299 pence, meaning taxpayers are currently sitting on a loss of 17.5 billion pounds.

The timing of a share disposal is inextricably linked to the fate of the British economy. Like state-backed rival Lloyds , RBS's domestic focus means profitability will be constrained until UK growth picks up.

The government said last week that the economy is to grow far more slowly than previously thought.

While the headlines may suggest otherwise, Hester is widely regarded within the industry as having almost restored the bank to health. He has had to do this while juggling competing pressures to lend and to deal with squeezed borrowers, while keeping government interference at bay.

"We're totally supportive of board and management, and management has done a really good job in a really difficult situation," one major shareholder told Reuters last month.

Having come this far, Hester is expected to stay on to oversee the government's first share sale, possibly in 2014, and would be unlikely to move on immediately.

If he gets to that point, the eldest son of a university professor will have earned his place in the history books.

(This story has been refiled with byline)

(Additional reporting by Sinead Cruise and Steve Slater; Editing by Alexander Smith)

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