It’s not often that Philip Hammond can lose over 2 billion quid and congratulate himself on a job well done. Nevertheless, the famously dour UK chancellor deserves limited abuse for selling a 7.7 per cent stake in Royal Bank of Scotland (RBS.L) for 271 pence per share. While that’s well below the 502 pence average price the government paid to rescue the bank during the last financial crisis, he has some reasonable excuses.
Hand-wringers should get a grip. The RBS bailout – for a total of 45.5 billion pounds – is a sunk cost. Rescuing the hapless lender’s then-shareholders from being wiped out was an indirect consequence of salvaging UK economic stability in the teeth of the worst financial crisis in a generation. The fact that the share price is just above half what the government paid back then is immaterial, even though the 3.5 per cent discount to market price is paradoxically wider than the 2 percent knocked off last time the government sold to investors in 2015 despite the lender being demonstrably healthier.
Still, the deal valued the government’s 70 per cent stake – now 62 per cent – at around 23 billion pounds, well in excess of Hammond’s plans to raise 15 billion pounds by selling shares in RBS through 2023. It is also probably more than RBS is worth, at least in the medium term, given it is only expected to make a lowly 3 per cent return on tangible equity this year, according to an Eikon-compiled analysts’ consensus.
RBS is projected to earn 20 pence per share in 2019. Assuming a 284 pence tangible book value per share, that implies a 7 per cent return on tangible equity. Assuming also a 10 per cent cost of equity and zero growth, a Gordon Growth Model would imply the shares should trade at a 30 per cent discount to book, or around 200 pence.
In that light, the deal looks more acceptable. With RBS outperforming main rival Lloyds (LLOY.L) by 13 per cent over the past year despite being unlikely to make an economic return by 2020, investors are not applying much of a Brexit discount. As such, Hammond is justified in cashing some chips now.