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Aug 4

Written by: Donald van Deventer
8/4/2011 2:29 AM 

Today’s blog focuses on the U.S. dollar funding shortfall that took place at Royal Bank of Scotland PLC’s New York branch during the period from February 8, 2008 to March 16, 2009. We also include borrowings by RBS Citizens Bank during that period. Our previous blogs have found that most institutions analyzed to date have primarily relied on “primary, secondary and other extensions of credit” by the Fed. Unlike most of the other financial institutions analyzed in this series to date, entities for which the Royal Bank of Scotland Group was the sponsor were very significant borrowers under the Federal Reserve’s Commercial Paper Funding Facility. In aggregate, the Royal Bank of Scotland Group received major support from the Federal Reserve in spite of very significant aid from the U.K. government during the credit crisis.

This is the twentieth Kamakura case study in liquidity risk, following earlier blogs on AIG, Bank of America, Countrywide Financial, Merrill Lynch, a consolidation of the latter three firms, Lehman Brothers, Morgan Stanley, Citigroup, Dexia SA, Depfa Bank plc, Barclays, Goldman Sachs, the combined JPMorgan Chase, Washington Mutual, and Bear Stearns, Wachovia, State Street, BNY Mellon, HSH Nordbank AG, Societe Generale, and HBOS/Bank of Scotland.

Under the Dodd-Frank Act of 2010, the Board of Governors of the Federal Reserve was required to disclose the identities and relevant amounts for borrowers under various credit facilities during the 2007-2010 financial crisis. These credit facilities provide perhaps the best source of data about liquidity risk and funding shortfalls of the last century.  This data is available for purchase from Kamakura Corporation and is taken from the Kamakura Risk Information Services Credit Crisis Liquidity Risk data base. We use this data to determine to what extent there was a funding shortfall at Royal Bank of Scotland PLC New York Branch, U.S. subsidiary RBS Citizens Bank, and the Royal Bank of Scotland Group during the credit crisis.

The data used for Royal Bank of Scotland in this analysis are described in more detail below. The data consist of every transaction reported by the Federal Reserve as constituting a “primary, secondary, or other extension of credit” by the Fed. Included in this definition are normal borrowings from the Fed, the primary dealer credit facility, and the asset backed commercial paper program. Capital injections under the Troubled Asset Relief Program and purchases of commercial paper under the Commercial Paper Funding Facility are not included in this definition put forth by the Federal Reserve.  We analyze borrowings under the Commercial Paper Funding Facility separately.

A detailed chronology of the 2007-2009 credit crisis is given in these two recent blog posts:

van Deventer, Donald R. “A Credit Crisis Chronology Part 1 Through February 2008: This Time Isn’t Different,” Kamakura blog, www.kamakuraco.com, May 13, 2011.

van Deventer, Donald R. “A Credit Crisis Chronology Part 2 March 2008 Through March 2009: This Time Isn’t Different,” Kamakura blog, www.kamakuraco.com, May 14, 2011.

Headlines relating to Royal Bank of Scotland were common during the credit crisis. They can be summarized as follows:

October 8, 2007
A consortium led by the Royal Bank of Scotland has won the battle to buy the Dutch bank ABN Amro. About 86% of ABN Amro's shareholders have accepted a 71 billion euro ($98.5 billion; £49 billion) offer to clinch Europe's biggest ever banking takeover (Source: BBC).


December 6, 2007
The Royal Bank of Scotland announces that it expects to write down 1.25 billion pounds sterling because of exposure to the U.S. subprime market. (Source: BBC)


April 23, 2008
Royal Bank of Scotland announces Britain's biggest rights issue (Source: The Times).


August 8, 2008
The Royal Bank of Scotland reports a £691 million loss in the first half of 2008 due to £5.9 billion in write downs linked to subprime U.S. mortgages (Source: Financial Times).


August 10, 2008
The Royal Bank of Scotland sells $8 billion of deeply discounted bad debt to private equity firms (Source: Financial Times). 


August 12, 2008
Banks like Citigroup, Deutsche Bank, and the Royal Bank of Scotland have sold $25-30 billion of bad loans at discounted rates to private equity firms. However, banks still remain at risk because private equity firms will only cover up to 20 cents on the dollar before additional losses are shared with banks (Source: Financial Times).


October 7, 2008
Bank of England provides emergency liquidity assistance to Royal Bank of Scotland (Source: Bank of England).


October 8, 2008
UK government announces bank recapitalization fund and other support measures totaling up to £500 billion (Source: HM Treasury press release). This involved a £20 billion injection of capital into Royal Bank of Scotland (RBS) in exchange for shares (Source: HM Treasury web site).


October 13, 2008
Royal Bank of Scotland Group PLC, HBOS PLC, and Lloyds TSB Group PLC will get an unprecedented 37 billion-pound ($64 billion) bailout from the U.K. government (Source: Bloomberg).


October 13, 2008
RBS will offer its shareholders the right to buy £15 billion of new shares, the vast majority of which are expected to be left with the Government, giving it a 60 per cent stake (Source: The Times).


October 13, 2008
Royal Bank of Scotland gains access to Credit Guarantee Scheme of the Bank of England (Source: Bank of England).


October 17, 2008
Emergency liquidity assistance to Royal Bank of Scotland from Bank of England peaks at £36.6 billion (Source: Bank of England).


December 16, 2008
Royal Bank of England repays emergency liquidity assistance to Bank of England (Source: Bank of England).


January 18, 2009
RBS suffers biggest loss in UK history. Royal Bank of Scotland (RBS) will this morning unveil up to £25 billion of losses for 2008 from increasing bad debts and a vast goodwill write-off on its acquisition of Dutch bank ABN Amro (Source: The Telegraph).


January 19, 2009
U.K. unveils second bank rescue plan. British government launches wide scale insurance plan to protect banks against further losses and boost lending (Source: CNN).


January 19, 2009
Shares in Royal Bank of Scotland collapsed today in the wake of the Government's latest rescue bid and news that the bank is facing the worst loss in UK corporate history. The NatWest parent company's market value slumped below £5 billion after shares plunged by as much as 70 per cent at one stage (Source: The Independent).


January 25, 2009
A radical restructuring at the Royal Bank of Scotland may see as many as 30,000 job losses in the next three to five years, says a media report (Source: The Sunday Times).


February 26, 2009
Royal Bank of Scotland (RBS) has announced the largest annual loss in UK corporate history and is to receive a further £13 billion of taxpayers' cash (Source: BBC).


February 26, 2009
RBS is getting a total of up to £25.5 billion. The bank will receive £13bn once the scheme has been finalized, and also has the option to request another £6bn in the future if needed. It is also, in effect, receiving another £6.5 billion, because the Treasury agreed to subscribe for £6.5 billion of B shares to cover the fee for the insurance scheme (Source: The Guardian).


February 26, 2009
Royal Bank of Scotland needs to sell up to £19.5bn new B shares to the taxpayer in order to insure £300 billion of its most troublesome assets. As a result, the taxpayer's voting rights over the bank would increase to 75% from almost 70% now. But Stephen Hester, the new chief executive, said the government's "economic interest" could rise to 95% "depending on how things work out" (Source: The Guardian).


February 26, 2009
Royal Bank of Scotland is placing assets valued at £325 billion with the asset protection scheme. This means that RBS will be liable for the first £19.5bn of future losses on these assets, after which the government will cover 90% of future losses. RBS says it will cut its exposure to bad debts by £144 billion, or 25% (Source: The Guardian).


November 3, 2009
R.B.S. agreed to take an additional £25.5 billion from the U.K. government, making it the costliest bailout of any bank, and to accept help in containing potential losses from impaired assets. In exchange, the government would increase its stake in the bank to 84.4 percent, from 70 percent (Source: New York Times).

This blog reports on “primary, secondary, or other extensions of credit” by the Federal Reserve to Royal Bank of Scotland PLC New York Branch during the period February 8, 2008 to March 16, 2009. We include borrowings by U.S. affiliate RBS Citizens Bank in these summary statistics:

Borrowing dates:
First borrowing February 29, 2008, for a total of $706 million.
Average from

2/8/2008 to 3/16/2009
$49.3 million
Average when Drawn
$2.8 billion
Maximum Drawn
$8.4 billion on October 6, 2008.
Number of Days with

Outstanding Borrowings
7 days

When looking at the primary source of Fed lending to the other banks in this series, RBS New York Branch and RBS Citizens showed shockingly few borrowings. The graph below shows the pattern of RBS Bank of Scotland PLC New York Branch and RBS Citizens borrowings, which fell on only 7 days.



It would be logical to conclude that the Federal Reserve played a minor role in making up the funding shortfall at Royal Bank of Scotland PLC, but that conclusion would be dramatically incorrect, as we explain below.

Default Probabilities During the Credit Crisis

The graph below shows the 1 year Kamakura Risk Information Services default probabilities for Royal Bank of Scotland Group for the full period covered by Fed disclosures, from February 8, 2008 through March 16, 2009.  Default probabilities for Royal Bank of Scotland Group rose dramatically during this period, with one year default probabilities ending at 45.45% on March 16, 2009.  The distress of the RBS Group was extreme, and that is why the modest borrowings from the Fed shown above are so surprising.  As it turns out, other borrowings were quite high. We analyze those borrowings below.



By March 16, 2009, Royal Bank of Scotland Group’s cumulative default risk was 53.46% for 5 years and 76.01% for ten years, even after tens of billions of pounds sterling in support from both the Bank of England, and, as it turns out, the Federal Reserve via the Commercial Paper Funding Facility.



In the chart below, we compare Royal Bank of Scotland’s consolidated funding short fall to those firms whose liquidity risk we have previously analyzed in this series.  Royal Bank of Scotland’s consolidated funding shortfall, measured by average drawn borrowing of $2.8 billion, ranks 19th among the firms analyzed in this series to date, a surprising result for an institution in such severe distress.  It turns out that this view is incomplete and the true degree of U.S. dollar funding support was much higher.



If one ranks the same firms by largest outstanding borrowing on a single day, Royal Bank of Scotland ranks 17th, with a maximum borrowing of $8.4 billion:



Borrowings During the Bear Stearns Crisis, March 14, 2008 to May 31, 2008

Royal Bank of Scotland’s borrowings during the Bear Stearns crisis from March 14 to May 31, 2008 were also surprisingly modest. Ranked by average borrowings during the period, the combination of Royal Bank of Scotland PLC New York Branch and RBS Citizens Bank ranked 21st among major institutions.



When ranked by maximum borrowings, Royal Bank of Scotland PLC New York Branch and RBS Citizens ranked 14th, just behind Lehman Brothers.



Borrowings from the Commercial Paper Funding Facility

Next, we turned to the Federal Reserve’s Commercial Paper Funding Facility.  With the exception of AIG, most of the other firms analyzed in this series showed a very small number of transactions under this facility. The Federal Reserve’s disclosure of borrowings under the Commercial Paper Funding Facility for the Royal Bank of Scotland Group showed a very large number of transactions for three special purpose vehicles sponsored by the Group:



If we analyze the origination dates and maturity dates of each of the transactions above, we see from the Commercial Paper Funding Facility (“CPFF”) the kind of massive Fed support for Royal Bank of Scotland Group that we expected (but didn’t) see via the “primary, secondary, and other extensions of credit.”  We summarize the CPFF borrowings here from February 8, 2008 to October 31, 2009 (since data is available past the March 16, 2009 end date for Fed disclosure on the other borrowings):

Borrowing dates:
First borrowing October 27, 2008.
Average from

2/8/2008 to 10/31/2009
$5.5 billion
Average when Drawn
$9.7 billion
Maximum Drawn
$20.46 billion on April 22-26, 2009.
Number of Days with

Outstanding Borrowings
357 days

This is much more borrowing than the Bank had through the more normal Fed borrowing facilities.  The graph below shows the pattern of outstandings under the CPFF borrowing program.



We now combine the borrowings under the CPFF with the “primary, secondary and other extensions of credit” to Royal Bank of Scotland PLC New York Branch and RBS Citizens. The comparison with the other firms analyzed in this series is not exactly correct because we have not included their borrowings, if any, under the CPFF.  With the exception of AIG, however, most of the banks analyzed had few or no CPFF borrowings.  This revised comparison shows that the Royal Bank of Scotland Group, when ranked by average borrowings outstanding on days when credit lines were drawn, ranked 12th with $9.6 billion in funding shortfall over 364 borrowing days, just behind Goldman Sachs in terms of Fed support. On the days it borrowed, the RBS Group had a higher borrowing amount than Lehman, Countrywide, or Bank of America (excluding Countrywide and Merrill Lynch prior to merger close dates).



The RBS Group’s maximum borrowing of $20.46 billion ranks 15th, behind Goldman Sachs and $7.46 billion more than Bank of America’s maximum borrowing of $13 billion (as usual, in this series, we exclude TARP capital purchase program financings).



Implications of Funding Shortfall Data

The Royal Bank of Scotland Group’s rescue is ranked by U.K. analysts as the largest bank rescue in history.  That view is normally based solely on funding provided by the Bank of England and the U.K. government.  Today’s blog shows that the Federal Reserve also played a major role in the rescue of the Royal Bank of Scotland Group, particularly via the Commercial Paper Funding Facility.  This support by the Fed continued through October 2009, long after most of the major U.S. banks had repaid their borrowings under the Fed’s “primary, secondary and other extensions of credit.”  Why was the Federal Reserve playing such a major role in supporting Royal Bank of Scotland Group even after huge capital support by the Bank of England and the U.K. government? The answer to that question deserves to be made public.

Background on the Federal Reserve Data

A summary of the Federal Reserve programs that were put into place and summary statistics are available from the Federal Reserve at this web page:

http://www.federalreserve.gov/newsevents/reform_transaction.htm

Today’s blog focuses on one set of disclosures by the Federal Reserve: primary, secondary and other extensions of credit by the Fed.  This includes direct, traditional borrowings from the Federal Reserve, the primary dealer credit facilities, and the asset backed commercial paper program described at the link above.  These borrowings do not include the equity stakes taken by the U.S. government under the Troubled Asset Relief Program. We separate discuss commercial paper purchased under the Commercial Paper Funding Facility.

Kamakura took the following steps to consolidate the primary, secondary and other extensions of credit:

  • From www.twitter.com/zerohedge Kamakura downloaded the daily reports, in PDF format, from the Federal Reserve on primary, secondary and other extensions of credit from February 8, 2008 until March 16, 2009, approximately 250 reports in total
  • Kamakura converted each report to spreadsheet form
  • These spreadsheets were aggregated into a single data base giving the origination date of the borrowing, the name of the borrower, the Federal Reserve District of the borrower, the nature of the borrowing (ABCP, PDCF, or normal), the maturity date of the borrowing, and (in the case of Primary Dealer Credit Facility) the name of the institution holding the collateral.
  • Consistency in naming conventions was imposed, i.e. while the Fed listed two firms as “Morgan Stanley” and “M S Co” Kamakura recognized to the maximum extent possible that they are the same institution and used a consistent name
  • To the maximum extent possible, the name of the ultimate parent was used in order to best understand the consolidated extension of credit by the Fed to that firm.

For information regarding the Kamakura Credit Crisis Liquidity Risk data base, please contact us at info@kamakuraco.com.  Please use the same e-mail address to contact the risk management experts at Kamakura regarding how to simulate realistic liquidity risk events in the Kamakura Risk Manager enterprise-wide risk management system.

Donald R. van Deventer
Kamakura Corporation
Honolulu, Hawaii
August 4, 2011

© Copyright 2011 by Donald R. van Deventer, All Rights Reserved.

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