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Why I Continue To Tip Royal Bank Of Scotland Preferreds

From Thursday's email about Royal Bank of Scotland, whose preferreds we recommend: Carney breaks with King in pledge to stand behind banks • 1:19 PM October 24, 2013:

"Bank of England Governor Mark Carney continues to remake the U.K. central bank into something more "Fed-like." In a major speech and even more major break with his predecessor at the bank, Carney makes it clear the BOE will stand behind lenders facing liquidity issues and rejects the country's antipathy towards the sector.
"'If organized properly, a vibrant financial sector brings substantial benefits . . . The UK's financial sector can be both a global good and a national asset ... The BOE today is the friend of resilient banks, continuous markets, and good collateral.'
"'The Bank of England's task is to ensure that the UK can host a large and expanding financial sector in a way that promotes financial stability.'" (end of note.)

The new Bank of England governor is not going to attack bankers because Britain needs them: for jobs, for prestige, for access to money, for real estate growth, for global clout.

Meanwhile split scare has succeeded in pushing down our favorite yield stocks, preferreds from RBS, after an article about how Britain might default on its RBS bond obligations failed to achieve this. The split into a bad bank-good bank was written up by the Sunday Telegraph, a British newspaper, on October 20. It was probably a leak from the UK government.

The misinformation-packed article on these pages claimed that RBS had defaulted in 2008 and might do so again; and that it was only 54% government owned. The article warned that RBS bonds had a high default risk.

RBS did not default in 2008, having been rescued by Gordon Brown's and Alisdair Darling's Labour government after a failed bond issue led to a run on the bank by panicked depositors. Labour fired the former managers who deserved it. The bank did not default, meaning that depositors and bond holders got their money. Common shareholders were wiped out. Preferreds were not treated as well, as you can read.

The 2008 events mean that Her Majesty's Government owns 82% not 54% of the RBS common stock. The current Tory-Liberal Democrat government hates the idea of a nationalized bank and last weekend leaks indicated that the present government might split RBS. However, a split would not end the obligation of the UK to pay dividends on the preferred shares we own. It is set by prospectus: no common payouts until the preferred shares get their dividend.

The 2008 bailout deal tried to go on paying preferred shareholders under the obligation to pay them before common (i.e. UK government) shareholders. This could only occur (as it did) because the European Union blocked the preferred dividends as giving an unfair advantage to state-owned banks in competition with private ones. Various RBS preferred payouts were suspended under Brussels rules (which the British could not overrule) for 18 months but are now all paying like clock-work.

The UK government, home of the largest non-US financial center, unlike the US Congress, is not playing with defaulting on government obligations. The costs are much higher than the already considerable ones in the USA from the recent Capitol Hill clowning.

Now Canadian-born central banker Carney, recently hired to run the Bank of England, their central bank, has weighed in with more support for its troubled banks. Britain will not make them walk the plank into the Thames or withdraw its support and force them into default on their debts (or preferred shares.)

But what will occur is that RBS will have to give up assets to private buyers to reduce the Labour government's bailout cost, selling off insurance companies, fund managers, investment banks, and private banks its disgraced former managers poured money into before the tide turned against debt-financed pseudo-growth. It is not just RBS but also Lloyd's Bank and some mortgage banks which were taken over by the UK government during the 2008 Global Financial Crisis. That there are a number of banks the government owns is another reason why CB governor Carney is not baring his fangs against the banks he regulates.

Asset sales by RBS include a US sub, Citizens Bank; an insurance firm in Brazil, its money market fund sub in Britain-- that's so far. Future sales will include maybe National Westminster, an internet bank, a joint venture in the Persian Gulf, and other assets which can be priced separately from the main bank.

The main bank that is left will be put on the block when it can command a price that gives the UK government back what its bailout cost in the first place.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

Additional disclosure: I own the following series of Royal Bank of Scotland preferreds: F, P, E, G, I, and National Westminster C.