Back up to speed


15 March 2010


Are we on the road to recovery? Paul Ward, head of corporate coverage and advisory at RBS, looks at the task of rebuilding market confidence after arguably the worst financial crisis since the Great Depression.


American President Calvin Coolidge, as famed for his probity as for his lack of humour, cautioned in the 1920s that "those who trust to chance must abide by the results of chance".

What would he have said about the past 18 months?

Today, as he might have predicted, the market is certainly living with the results of its actions. And, it must be said, companies are adapting accordingly; some better than others. Organisations have had to make huge changes and look to the core of their operations. Royal Bank of Scotland (RBS) is one of them. Now, with a new management team, structure and strategy in place, the bank is facing the future with a renewed commitment to clients.

Crisis of confidence

What do we mean by confidence? According to Dr Johnson, who compiled the first Great Dictionary of the English language around 250 years ago, "Confidence is a plant of slow growth". He knew what he was talking about. Johnson lived through the trauma of the notorious South Sea Bubble, one of the greatest confidence shakers in Britain's economic history.

Or, a more contemporary take on confidence comes from the Oracle of Oklahoma, Warren Buffet: "It takes 20 years to build a reputation and five minutes to lose it."

The banking sector's five minutes was directly related to poor risk stewardship. In retrospect, it is easy to identify the contributing factors: over-confidence in managing highly complex new product engendered complacency, which in turn led to high leverage ratios. Finally, risk and reward models were no longer fit for purpose.

As a result, banks went from being solution providers of capital, points access to capital markets and trusted advisors, their traditional role, to being part of the problem. All of this challenged the system as never before.

Have we moved on?

At last, health is returning to capital markets. A good indicator of this is equity issuance. A hefty proportion of the FTSE 350 issued a total of £30 billion in 2009. And the year saw £62 billion in bond issuance by UK corporates. This is a noteworthy figure, even if the pace has recently slowed to more 'normal' levels. That in itself can be viewed as another encouraging sign.

M&A is also on the upswing and the equity markets have performed particularly well. Another good indicator is the investment world's regained appetite for risk. The credit spreads are really beginning to come in while, at the same time, volatility is on a generally downward trend, a few blips notwithstanding.

Is confidence finally returning?

What do these indicators tell us? Could confidence be finally improving? The Vistage 2010 index of CEO confidence certainly suggests it is. After dipping to its lowest point in Q4 2008, the index has steadily climbed and levels are now on a par with those of Q1 2007.

The evidence is there, but how robust is that feeling of returning confidence? And will it last?

Recent events do seem to suggest some strain. The headlines about the banking system have not helped. Coverage of what is bound to be a protracted discussion about regulation, policy and business models could shake fragile investor confidence in the system as a whole.

And what about the Greek tragedy? A joint European and IMF rescue package has been endorsed. As a result, the economy might still be patched, but only if the home of stoicism faces up to some hard fiscal truths, as represented by the nation's new sub investment grade.

But even more worrying is the risk of contagion. This has hit several countries, now referred to collectively as PIIGS - Portugal, Ireland, Italy, Greece and Spain. A more localised concern is whether or not the UK will be able to curb its swinish tendencies as far as sovereign risk is concerned. No matter who is in - or shares - power, some things are certainties: a budget geared to austerity, rising rates, volatility in both equities and currencies and finally tighter regulation.

Some of this is already happening globally. Both Basel 3 and Solvency 2 will call for increased capital requirements for banks. According to McKinsey's analysis of 25 global banks last month, a capital requirement of $600 billion over the next five years will be required, even before Basel 3 issues its report.

What could a more confident future look like?

Will there be a dreaded double dip? It is still a risk. But optimists can take some comfort that the normally cautious JP Morgan's Jamie Dimon said the prospect of a double dip 'is rapidly going away.' Tesco's Terry Leahy, who issued a bumper profits announcement recently, thinks along the same lines.

Recent developments bear that out. Against the backdrop of moderate macroeconomic data out of Asia and the US, the market shrugged off disappointing results from Alcoa and Google and rose on positives from Intel, UPS and JPM Chase.

But to give a balanced view of the future, we should acknowledge the opinions of the bears. RBS provides a den for one of the most prominent bears in the UK, Bob Janjuah, Chief Markets Strategist, who is frankly unimpressed by the recovery. He regards it as largely delusional, based on three major misconceptions about relying on exports, inflation and quantitative easing. For him, government priorities should be to raise taxes, cut costs and grit their teeth and impose a period of austerity.

And yet we can still get hit by something out of the blue. Or out of the ground. Who could have predicted the global impact of an eruption by an Icelandic volcano? Airspace closed for days, airlines, airports and economies lost billions and the final bill is still increasing with subsequent plumes of ash causing local airspace closures.

How can corporations regain trust?

That is a question that has long been front of mind for those of us in the banking sector. The first step, of course, is to acknowledge mistakes. But that is not enough. Changed behaviours must follow to prevent a recurrence of those errors that got the sector into trouble in the first place. Moreover, all of this has to be done in the open, with shareholders, clients, staff and other stakeholders as witness to any tentative first steps on the road to change and recovery.

At times of stress, like those from which we are all just emerging, customer confidence can evaporate if we do not take the time to empathise with them. We need to make it our business to understand customers' doubts and concerns and act accordingly. As to our success in those efforts, our clients have to be the ultimate judge. However, the figures do suggest RBS is on the right track. Last year we lent a total of £60 billion to UK businesses and we are currently approving around 85% of loan applications for our SME customers. That works out to about 5,000 new business loans every week and is bound to make a positive difference to the UK economy.

And in 2009, all things considered, we had a very respectable year. Our group revenue was £29.4 billion, with operating profit of £8.3 billion. Our core tier 1 ratio is 11%. Looking ahead, achievable milestones will be a return to an AA rating and a UKFI sell down. At the same time, we are working to give our customers all the support they deserve. But there is more that we can do.

In the past couple of years there has been a shift in UK and European finance; a move towards the American model where corporates are relying more on capital markets services than on traditional bank lending. For example, data from Dealogic for European investment grade corporates show that, of total debt supply - meaning loans and bonds - bonds comprised 17% in 2007. In 2008 it was 28%. By 2009 the figure was 65%. That is a considerable jump and even if it falls back a bit this year, the trend is apparent. And it is a trend RBS is more than ready to handle.

Although we have changed, and have been winding down businesses that did not help us serve our core clients, we have kept and enhanced our key strengths. That includes those in origination and execution for our clients across equity and debt capital markets. Just as important, we are maintaining investment to develop our cash management and money transmission services.

As ever, RBS is a strong presence, here in the UK and around the world. And we are committed to our clients wherever they choose to do business. We are all certainly in a better place than we were a year ago. For one, here in the UK, businesses can raise money again. That has to be progress.

Create confidence

As I mentioned at the start, improving macroeconomic data is whetting the appetite for risk. Clearly there are sufficient quantities of cash around to feed that desire. The economic news from the US is increasingly promising - even with the confidence-shaking disaster in the Gulf of Mexico. Over the last month, defensive sectors such as natural resources and pharmaceuticals have significantly underperformed cyclicals as investors look to recovery. All of that bodes well for us in the UK - particularly once we have greater political clarity.

Work together

At RBS we are ready, willing and more than able to support UK plc with lending and balance sheet including a banking facility with enough liquidity and headroom. We can be of service when it comes to more manageable gearing levels coupled with higher efficiencies and working capital. And we can help with the bank's own capital and market access when it comes to divestment possibilities and acquisition opportunities.

This optimism has to be underpinned by regulatory changes that will re-build solid market confidence for the long term. That is what business wants. That is what RBS wants. And that is what we should work together to achieve.