Royal Bank of Scotland’s chief executive of its non-core division predicted there would be no huge sell-off of loans and few 'Project Isobel'-style transactions in the future as the bank continues to wind down its £94 billion of unwanted assets.
Rory Cullinan apologised if the news came as a disappointment to private equity real estate delegates in a pre-recorded interview screened at the PERE Summit: Europe, but he said the bank’s most efficient strategy toward its remaining £35 billion (€43 billion; $54 billion) of non-core real estate involved running off assets. “I apologise to people in the audience. It is often stated there is going to be a flood of large loan sales, but I don’t see it happening in any scale.”
Cullinan explained how selling assets was often “not the most capital-efficient way of winding down its non-core portfolio”. He noted that RBS had written off 10 percent but, of the remaining 90 percent, half of the assets would be “run off” and half would be “actual sales”, with running off assets being the most capital-efficient course of action.
Cullinan said that, within the real estate sector, it had been a challenge to sell assets. “It has been fundamentally an issue of cost of (a fund’s) capital, rather than their return hurdles. What people sometimes forget is that everyone wants 15 percent, the bank included. The difference for the bank is that the bank is the most capital-efficient to hold those assets because the bank can gear itself at eight or nine to one. Most funds would be lucky to get 50 percent.” He added that, unless funds could access higher gearing, it would remain “incredibly challenging” for those private equity real estate funds to “play”.
RBS set up its non-core group in 2009 and designed it as a vehicle to reduce the institutional risk within the bank. Some £285 billion of assets went into the non-core group, including £70 billion of real estate across the globe in different asset classes. Cullinan said the size of the non-core group was initially larger than the balance sheet of Standard Chartered Bank and Greece.
By the end of last year, RBS had reduced its non core group to £94 billion of assets against its original target of about £118 billion by the end of 2011. That gives the bank another two years to reduce to around £40 billion. Of the original €70 billion of real estate, the portfolio has been reduced by 50 percent. It has sold its directly-owned assets such as pubs and hotels including the Cumberland and Grosvenor House in London.
Speaking about Project Isobel, the 2011 real estate transaction with The Blackstone Group named after his daughter, the chief of the non-core division said the project originally started out as ‘Project Monaco’ with some £3.4 billion of assets that needed “better management and a more efficient cost of capital applied to it”.
The bank went on a “fishing exercise” to sell the £3.4 billion portfolio but discovered no potential buyer could raise the money required. Therefore, RBS decided to reduce the portfolio to a residual part and renamed it Project Isobel as a collection of loans that needed “hands-on management potentially going into a recovery phase plus enforcement and active restructuring over time”.
Cullinan joked: “Project Isobel was named after my daughter. She was 15 when it started and 17 when it completed, so obviously it has been a bit of a journey.”
Asked whether there would be many other Project Isobel-type structured transactions, Cullinan said: “I think there will be very few of those transactions going forward.”
On Europe’s banks in general, Cullinan insisted: “It has been clearly signposted that there is going to be a large volume of loans coming to the market, but so far that just hasn’t happened and I don’t see it happening going forward in any significant scale.” He said the reason for that was simple, but not well explained by the market.
European banking stress tests showed Europe’s banks had a €115 trillion “hole”, but up until September banks had actually increased their balance sheets by one percent, not decreased them. Only three banks had actually shrunk the balance sheet, of which RBS was one.
“Deleveraging is a bit of a myth. The problem is whether you are forced to sell loans at a discount, but there is a reasonable chance you are going to destroy capital, so you get into a death spiral.” Plus, he noted that action by the European Central Bank had eased some of the pressure.