This CDS report was written by Markit’s Gavan Nolan
It is not often that a company reporting a £24.1 billion net loss for a year – a UK record – would be regarded as a cause for celebration. But these are extraordinary times, and Royal Bank of Scotland is no ordinary company. The figures were no great surprise to the market, and in some respects were better than expected. Most of the loss – £16.2 billion – was due to a goodwill writedown on its near-fatal acquisition of ABN Amro. But the real focus was on the bank’s participation in the government’s asset protection scheme. RBS is putting £325 billion of its assets in to the scheme – more than expected. The terms are also more favourable to the bank than many supposed. RBS will be liable for the first £19.5 billion of losses. If further losses are incurred, 90% will be absorbed by the government, with RBS exposed to the 10% residual. The cost for the insurance will be £6.5 billion in non-voting B-shares. The government will increase its stake even more as RBS is issuing more B-shares to fund the initial tranche of losses.
Even taking into account the sacrifice of some tax allowances, the insurance looks cheap. The bank’s creation of a bad bank and its participation in the scheme has created some optimism, however tentative, that government measures could be effective in stabilising the banking system. Lloyds Banking Group, due to report tomorrow, has also said it will buy insurance form the government.
Both the credit and equity markets rallied in reaction to the news. The Markit iTraxx Europe index tightened to 174.5bp, nearly 6bp tighter than yesterday’s close. Credit improvement was not confined to financials. Tightening credits outnumbered widening names by about three to one. German chemicals group BASF saw its cost of protection fall, despite posting a larger than expected quarterly loss. The firm’s sales beat consensus forecasts, though the company was downbeat about the coming year. French hotel group Accor was among the laggards following its disappointing results yesterday. There is speculation that the firm could be split into two, with uncertain consequences for bondholders.
In the US, credit markets were even more buoyant. The Markit CDX IG index was trading around 2bp tighter at 213bp, with tightening names outnumbering those that widened by around five to one. A fragile optimism was evident after the Obama administration revealed that it is set run up the largest budget deficit since the second World War. The $1.75 billion deficit, a combination of tax cuts and public spending, will stimulate the economy. But there will be a torrent of bad news before its effects will be felt, leaving spreads exposed to significant volatility.Retailer and apparel firm Limited Brands was one of the few names to widen after it posted a 96% fall in net income for the fourth-quarter. A write down at its La Senza lingerie chain made a large contribution to the loss. The firm also cut its earnings forecasts for the first-quarter and the full-year. On a positive note, Limited’s liquidity position is better than many of its peers and is generating sizeable free cash flow.