Moody's Views Possible Downgrade Of Royal Bank Of Scotland's Ratings

Moody's placed under review for possible downgrade the B Bank Financial Strength Rating and the Aa1 senior long term debt and deposit ratings of Royal Bank of Scotland plc and the Aa2 senior debt rating of Royal Bank of Scotland

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Moody’s placed under review for possible downgrade the B Bank Financial Strength Rating and the Aa1 senior long-term debt and deposit ratings of Royal Bank of Scotland plc and the Aa2 senior debt rating of Royal Bank of Scotland Group plc (RBS). The short-term P-1 ratings of both entities were affirmed. A separate press release will follow on the ratings of the Ulster Bank Group and RBS’ rated US subsidiaries.

The review will examine a number of factors which are pressuring the bank’s financial profile including (i) the ongoing volatility in earnings resulting from the bank’s capital market activities and credit market exposures, (ii) the bank’s significant exposures to commercial real-estate (particularly in the UK, Ireland and US), as well as (iii) the impact of increased provisioning and weaker earnings from its core UK franchise due to the accelerating downturn of the UK economy. The GBP 20 billion capital recently raised by the bank from the government provides a significant buffer against additional writedowns and provisions, however, the ongoing earnings volatility and expected decline in asset quality indicate that the bank’s ratings are less consistent with other B BFSR rated financial institutions.

Moody’s notes that RBS continues to suffer from market-related losses and has recorded cumulatively in 2007 and 2008 approximately GBP 7.4 billion in credit market writedowns as at end of September 2008, as well as a further GBP 1.2 billion that would have impacted the P&L if the bank had not reclassified certain assets under the IAS39 look-back option (of which GBP 682 million was charged to equity). In addition, the bank reported losses of approximately GBP1bn after the end of September in its Interim Management Statement of 4th November 2008, as well as potential losses of up to GBP 400 million related to the Madoff fraud.

As a dominant player in the UK retail and commercial banking markets, RBS will face higher provisioning costs and weaker revenues as a result of the accelerating UK recession, said Elisabeth Rudman, Vice President/ Senior Credit Officer at Moody’s. Rudman added that Moody’s considers RBS is less likely to be severely impacted by defaults in its GBP 79 billion UK residential mortgage book, which is conservatively positioned with relatively low LTVs, but more likely to see large increases in provisions from its commercial lending and commercial property exposures. With regards to the bank’s commercial property and construction exposures (GBP 111 billion globally and GBP 82 billion in the UK), Moody’s will examine in particular the bank’s UK and Irish books, given the significant price corrections still taking place in those markets and the likelihood of increasing tenant arrears and defaults.

The review will also take into account the mitigating factors that support the bank’s ratings. Moody’s expects that a number of RBS’ core franchises will continue to support the bank’s financial profile throughout the global economic downturn. The total GBP32bn of capital raised this year, which is available to absorb losses, has significantly improved the size and quality of RBS’ capital base (proforma capital ratios at the end of September 2008 were 7.9% core Tier 1 and 11.6% Tier 1 ratio on a proportionally consolidated basis). In addition, Moody’s expects the strategic review recently initiated by the bank to lead to a substantial de-risking, although the implementation of such changes in the current environment are likely to entail upfront costs.

With regards to funding, Moody’s noted that the bank has a strong and stable retail deposit base, however, the bank also has large wholesale funding requirements, which increased as a result of the ABN acquisition. RBS has utilised the government’s guaranteed debt scheme as well as other collateral-based facilities from central banks and Moody’s will consider in the review the likely level of dependence on such sources of funding.

A separate press release will be issued on the ratings of the Ulster Bank Group, RBS Citizens and its US affiliates.