David Prosser: Hester plays it safe at Royal Bank

The disappointment is not that RBS is hoping to insure fewer toxic assets via
the Government’s asset protection scheme, asking shareholders to stump up
£3bn of additional capital instead. On the contrary ? the City seems to
think RBS is not being aggressive enough about reducing its participation in
the APS, especially given the scale of ambition down the road at Lloyds
Banking Group. There, the chief executive, Eric Daniels, believes he may
still be able to raise sufficient cash to avoid the APS altogether. At the
very least, its right issue ? and thus the reduction of the APS
participation the bank can achieve ? is likely to be much larger.

There’s no doubt the APS is the sort of insurance policy that bank
shareholders would like to avoid in an ideal world. It is expensive ? the
taxpayer is demanding his piece of flesh ? and comes with a hefty excess,
requiring the banks to shoulder the first £25bn of losses on the assets they
insure. Above all, the only way Lloyds and RBS can meet the cost of the
scheme is to hand over a further slice of equity to the Government. Some 85
per cent of RBS could end up in public ownership under the scheme, while the
figure at Lloyds is an unpalatable 65 per cent.

Moreover, since the two banks first opened negotiations over the terms of the
APS six months ago, their share prices have recovered and confidence has
begun to return to the banking sector. Leading shareholders appear to have
indicated they would now be prepared to support cash calls.

It is for these reasons that there were mutterings yesterday about the
cautious approach of Stephen Hester, the RBS chief executive parachuted into
the bank earlier this year following its near total collapse.

Such mutterings are quite misplaced, however. For one thing, RBS’s intention
has always been to insure a greater chunk of assets than Lloyds ? it wants
to cover £325bn (versus £260bn at Lloyds) at a cost of £19bn (compared to
£15.6bn). Unlike its rival, it has no chance of avoiding the APS altogether.

Moreover, Mr Hester knows that many of his shareholders are still smarting
from the last RBS rights issue. The disastrous fundraising launched by his
predecessors last summer pulled in £12bn at 200p-a-share ? despite the
recent share price recovery, the participants are still sitting on some very
heavy losses.

Much more to the point, however, this is hardly the time to be taking a gamble
on the continuation of the fragile economic recovery of which we are only
just seeing a beginning.

Last month, Mr Daniels surprised many with an upbeat assessment of Lloyds’
trading prospects, reporting losses of £4bn but signalling that the bank’s
bad debts had peaked. What he seems to be saying now is that Lloyds does not
actually need the APS ? even though it has already racked up losses on the
toxic assets it would insure which amount to close to half the £25bn excess.

Let’s hope he’s right about the bad debt cycle. But what happens if the
recovery proves shortlived, or the assets in question prove to be even more
toxic than at first thought?

RBS, on the other hand, seems to want to play it safe ? an approach that
outside the City will rightly be applauded. It could probably persuade
shareholders to support a larger rights issue, but it is resisting the
temptation to do so.

One final thought: what explains the conflicting approaches of Messrs Hester
and Daniels (the RBS chief has also been markedly more pessimistic about the
short-term economic outlook)?

Could it be that having joined the bank only recently, and having been
applauded for stabilising it, Mr Hester’s job is not at stake? Unlike Mr
Daniels, say, who still fears the consequences for his continued employment
of his bank’s merger with Halifax Bank of Scotland ? and whose interests
therefore lie in painting as rosy a picture of the future as possible.

Should we keep scrappage fund on the road?

The campaign for an extension of scrappage starts here. Figures from the motor
industry suggest the Treasury is set to make a £100m profit on the scheme,
which offers cash incentives to drivers who trade in an old motor for a
shiny new vehicle.

While the project, which has boosted the struggling motor industry, comes at a
cost to the taxpayer of £1,000 for each new car bought, it also raises VAT.
And at the current VAT rate of 15 per cent, any car sold for more than
£7,600 produces more than £1,000 of tax. With the average car in the scheme
going for £9,000, the Treasury should make £100m of extra VAT, assuming that
300,000 vehicles are sold through the initiative, which is what scrappage
funding currently provides for.

Case closed for an extension of the scheme, then, which is what the motor
industry wants. Well, not entirely. For one thing, it may be that people are
simply diverting spending from other areas to pay for their new cars, in
which case the Treasury would have got its VAT anyway, without having to pay
for it. Also, the aim was always to kick-start a sustainable recovery ? at
some stage, the motor trade has to stand on its own two feet.

Still, one thing which might help the industry persuade the Treasury is the
end of the VAT concession, with the tax rate due to go back up to 17.5 per
cent at the beginning of next year. That will increase the value of the
scrappage windfall, should the scheme still be running.

It is an interesting dilemma ? not least because the retail trade is set to
mount its own campaign for further VAT concessions, arguing that the current
15 per cent rate should be extended into 2010. Retailers vs car dealers it
is, then.

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