It was understandable why Royal Bank of Scotland (RBS) hired investment bank Morgan Stanley back in 2014 to look into how it could retreat from the Republic, where its Ulster Bank unit had cost £15 billion (€16.8 billion) in parental bailouts over the previous five years.
All kinds of options were considered at the time, including talks about merging Ulster Bank with Permanent TSB (PTSB) or Belgian-owned KBC Bank Ireland, selling a majority stake to private-equity investors, and – as a fall-back – pulling out of the market entirely.
But it made little sense at the time for RBS to retrench, and the review came to nothing. After all, Ulster Bank had only just returned to profit for the first time since 2008 as banks started releasing some of the large bad-loans provisions set aside during the financial crisis. Ceding a majority stake at the time – with an economy in rapid recovery – would have handed the upside over to others.
In addition, RBS was trying at the time to spin off its Williams & Glyn unit under EU conditions attached to its government bailout. The execution risks attached to that transaction alone were massive. Trying to do something with Ulster Bank would have been too much.
Thirdly, the business in the Republic was intertwined in 2014 with Ulster Bank Northern Ireland under the Ulster Bank Group, making a deal even more difficult when RBS, majority owned by the UK government since 2008, would have been under political pressure to remain a force in the North.
Since then, however, the provision write-backs story has been well played out (with banks now back to setting aside money to cover expected Covid-19 losses), RBS has been let off the hook from selling Williams & Glyn, and Ulster Bank Group has been split into separate divisions, North and Republic.
Also, it has been clear that the economic surge in the past six years has not delivered acceptable returns, as the bank's loan book has shrunk dramatically to leave it a distant third to AIB and Bank of Ireland. Ultra-low interest rates have further squeezed income.
Ulster Bank’s running costs were between 95 per cent and 111 per cent of its income over the past three years – about double what banks typically target. The wider UK group’s cost-income ratio stood at 65 per cent in 2019. The Irish ratio is also a function of what costs are allocated to it and a large low-yielding tracker loan book.
The Irish unit's profitability, too, has stood out as a weak spot, with its net income amounting to 2.3 per cent of the equity that NatWest had invested in the business at the end of last year. The group's return-on-equity ratio was 9.4 per cent – about where you would expect a healthy bank to be. Covid-19 has only made things worse.
The Irish returns haven’t been helped by the fact that even after managing to convince regulators to allow Ulster Bank to hand €3.5 billion of surplus capital over to RBS over the past four years – the equivalent of about a fifth of its bailout bill – it is still being made retain one of the highest capital bases in Europe.
It’s common equity Tier 1 capital ratio – a measure of reserves that can absorb shock losses – stood at 26.5 per cent at the end of last year, double what most banks have as targets. It left as much as €2 billion of trapped capital.
Former RBS chief executive Ross McEwan was a staunch defender of the Ulster Bank unit, even if he conceded last year that it would be another "two to three years" before it would begin to made enough money to break even on its own funding costs. But his successor, Alison Rose, is on a mission, having moved this year to rename RBS as NatWest Group and unveil a plan to halve the size of problem investment banking unit she inherited.
The Irish Times reported on Thursday evening that Rose is actively considering winding up Ulster Bank in the Republic, though sources say that a tie-up with another lender is a possible, if less likely, outcome of a fresh strategic review.
A closure would mark the end of a storied bank and further erode competition in a market that has been hit by the exits of Bank of Scotland, Danske Bank and Rabobank from retail banking and demise of Anglo Irish Bank and Irish Nationwide since the crash.
Established in 1836 as a conservative Belfast-based lender – whose linen trade customers continued to thrive even as the island was ravaged by the Famine a decade later – Ulster Bank set up a Dublin office in the 1860s before merging in 1917, amid the uncertainty created by the Easter Rising, with London County and Westminster Bank, a precursor to NatWest.
RBS inherited an exposure to the Celtic Tiger economy in 2000 through its takeover of NatWest, before doubling down three years later in Ireland through the purchase of First Active.
With caution thrown to the wind, Ulster Bank in the Republic more than doubled its assets to €62 billion in the four years before the property bubble burst, fuelled by the bankrolling of boomtime developers such as Sean Dunne and the launching of the State's first 100 per cent mortgages.
Ulster Bank is now a shadow of its former self. As of June, it had net loans of €20.5 billion, a mortgage market share in the "mid-teens" per cent, 20 per cent slice of the SME market and "very strong corporate lending franchise", according Goodbody Stockbroker analyst Eamonn Hughes.
A wind-down would see market shrink from five surviving retail banks to four, fuel the dominance of AIB and Bank of Ireland and lead to the closure of 88 branches across the country.
It is highly likely that news of the strategic review will prompt an approach from 75 per cent State-owned PTSB, which has its own issues, to see if there’s a deal to be done.
With banks trading on the market at deep discounts to how they value their own assets, an accounting device that allows for the booking of the difference - known as badwill, or negative goodwill – as a gain in a merger is beginning to excite dealmakers. The tie-up agreed by Spain's CaixaBank and Bankia this week, for example, was fuelled by this.
The Government, caught off-guard by news of NatWest’s review, will not want to be seen sitting on its hands as the third biggest player in the Irish market eyes an exit.
But it seems clear at this stage that NatWest wants out.