Of banks and intimations

Last week a number of banks issued 2010 first-half results. Northern Rock, HSBC, Standard Chartered and Lloyds all released figures showing overall profits in their operations that were good given the current market conditions in their field of activity. All, including Northern Rock, were able to demonstrate the benefits of the "universal model" of banking and senior executives from these companies, both on and off the record, were keen to emphasise their belief in the continuance of this banking regime. Some executives hinted at possibly adverse consequences if forced into radical changes. The last two banks to issue their half-year results were Barclays Group and the Royal Bank of Scotland Group (RBS).

On Thursday 05 August 2010, Barclays Group reported that profits before tax for the first six months of 2010 amounted to £3.95 billion, up 44 percent on the same period last year, with total income of £16.58 billion, up eight percent. This figure is flattered somewhat by a £851 million, one-off gain on Barclays own credit so that adjusted profit before tax stood at £2.96 billion, a 22 percent increase. Profit after tax was £2.92 billion, an increase of 32 percent. The single largest profit sector for the Barclays Group was due to the performance of Barclays' investment banking division, Barclays Capital which made £3.4 billion, an increase of 225 percent over 2009's figure of £1.05 billion.

Contributing significantly to Barclays' bottom line, was a dramatic reduction in Impairment charges, down 32 percent to £3.08 billion and this despite an increase in Spanish bad debts provisions. Lower gross income in the Global Retail Banking sector "reflecting weak economic growth and further margin compression", still returned a higher net profit before tax of £901 million (2009: £845 million) due solely to these reduced impairment charges.

The lower income would appear to reflect an exposure to Spain where Barclays is the largest foreign bank and the sixth largest overall with 550 branches. It also has about 160 branches in Portugal. Both of these countries are struggling with large budget deficits and severe unemployment.

For Barclays Corporate division there was bad news offset by a little good. There was a very substantial loss of £756 million in Continental Europe and New Markets, Spain accounting for some £433 million of the total. This was partially offset by a profit before tax of £379 million in the UK and Ireland, a small increase of £10 million on 2009. It left Barclays Corporate division with an overall loss of £377 million.

In answer to the Chancellor of the Exchequer, George Osborne's exhortation to banks to lend more to help Britain's economic recovery, Barclays highlighted that their gross new lending to UK businesses and households in the first six months, totalled £18 billion. Ten billion of this went to households and small businesses. A further £7 billion was taken on with the acquisition of Standard Life Bank in January 2010.

Chief Executive, John Varley said: "We recognise our wider social responsibility as an enabler of economic growth and prosperity and our actions are, and will continue to be, informed by this duty." He also stressed that the Bank's "universal model" had proved best suited in weathering the financial crisis and should not be broken up. This was really a warning to the new government-appointed Commission on Banking "not to cause unintended consequences." Off the record, Barclays executives have indicated that in the event of a forced break-up, the Bank might move abroad, selling its UK assets.

In January 2009, RBS Group announced the biggest loss in British Corporate history of more than £24 billion, by which time the bank was more than four-fifths owned by the British Government. Following painful restructuring and job losses, the new Chief Executive, Stephen Hester, was able to announce earlier this year that RBS's net attributable loss for 2009 had fallen to £3.6 billion after completing the first year of a five year strategy. He announced at this time that he expected the Group to return to overall profit in 2011. The Bank's Core Tier 1 Capital ratio had increased between December 2009 from 5.9 per cent to near 11 per cent.

On Friday 6 August 2010, RBS Group was able to show that their corporate strategy has worked better than anticipated in that the Bank has posted an attributable profit for the first six months of 2010 of £9 million. Tiny though this sum is when analysing the annual accounting ratios for firms, it demonstrates a most commendable effort on the part of Mr Hester, his Board and the workforce of RBS and an encouraging trend in the turnaround from a £248 million first quarter loss to a £257 million second quarter profit.

RBS reported a stronger Retail and Commercial Banking performance than Global Banking and Markets performance during the second quarter "reflecting a weaker capital markets environment". Similar to other banks' results reported last week, outcomes were very much helped by falling impairment totals. In RBS's case, these fell from £2,675 million in the first quarter of 2010 to £2,487 million in the second quarter. The Core Tier 1Capital ratio decreased slightly to 10.5 per cent.

Stephen Hester, RBS Group Chief Executive, giving an interview to Cantos Productions on 6 August 2010, said that RBS's core businesses "are strong and getting stronger ... partly as the economy recovers and partly (the result) of the very strong management action we have had to take".

The CEO went on to say that the Bank's retail and commercial business was "nicely up" whilst the investment banking sector had experienced volatility and difficulty, particularly in the second quarter.

Whilst Mr Hester stated that very good progress had been made in selling off assets in the non-core businesses, repeating this point often in the 18 minute interview, he appeared less pleased with this aspect of his task with each repitition so that by the time the reporter asked about the status of RBS Insurance, he very firmly stated that he was "unhappy at having a whole list of disposals forced on us by our settlement with the EU".

I surmised from this that Mr Hester viewed RBS Insurance as a core part of the Group and that there was no reasonable or logical reason for it not to be. Having made his point, he continued: "Our plan is to wait until 2012/2013. We believe by that stage the business will be stronger and we shall get a better price, probably through a flotation."

At present was not a good time to dispose of the Insurance arm as RBS was restructuring the business "to make it more competitive, to recover from the problems in litigation and the no-claim, no-fee lawyer situation that has hit the UK motor industry. As we get that behind us, the business should strengthen".

Challenged by the reporter about rising profit margins on the back of increased charges to customers, Mr Hester said that RBS wasn't making sufficient profit to justify shareholders' investment and that the Bank had more to do to get it on the "sustainable basis where it needs to be".

As for pay and bonuses, the CEO said that RBS has been at the forefront of pay reform in banking, that only 10% of staff were affected by the controversial bonus issue, really the Investment Bank, and that the Bank took a responsible attitude whilst having to remain competitive by retaining "people who are with us, who are good and can benefit our customers".

How did he answer the Government's contention that the banks are not lending to businesses? Mr Hester replied: "We have a legal and moral responsibility not to repeat reckless lending mistakes. Not to deliberately lend to people we think are not viable ... we are lending large amounts of money to our customers where they want it. Actually more would prefer to save than borrow, but we're doing it where it's needed."

Here the reporter interjected to say that anecdotally, one out of three firms claimed that they could not get money from the banks. Mr Hester replied: "Before the recession and since, RBS has said "yes" to 17 out of 20 businesses that have asked us for money. We have £45 billion of overdrafts available to small businesses in the UK that they are not using, that they could use if they wanted that extra money ... Like in all recessions, people are tending to save more and pay back money rather than borrow more."

Finally, with regard to regulation and risk, Mr Hester said that he had no issue with learning the lessons of the financial crisis by putting in place more capital and applying more conservative liquidity arrangements. He stressed however that there was "absolutely no data from the crisis that you toppled over because of your size or your shape. You toppled over because you weren't managed well and you were represented in countries that did not manage their economies well. That's the data!"

Much of what Mr Hester said for RBS would ring true to a greater or lesser extent with his fellow CEOs of Britain's other banks. "Too big to fail" was a phrase used by President Obama for a banking system that is much different to that of the UK - there is no nationwide branch banking system in the USA but many thousands of banks, a few dozen of which go bust in any typical year.

Both Barclays and RBS benefited from their broad diversity of operations. Barclays' results were enhanced by its Barclays Capital investment arm whilst the opposite appears to be the case for RBS which had a poorer investment wing, especially in Q2, when its retail section came to the rescue. Horses for courses, let America sort out its own banking system. Here in the UK, with a beefed up and properly functioning FSA, Mr Hester's claim that "In a couple of years we will get to the position where, stand alone, RBS is one of the strongest banks in the world" will be true.