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RBS assets could pay off for patient private equity

Is there a pot of gold at the end of the rainbow? Private equity groups seem to think so. JC Flowers, AnaCap Financial and Corsair Capital are sniffing around the retail and business banking operation – codenamed Rainbow – that Royal Bank of Scotland has to sell. Banks are not an obvious fit for private equity. The traditional model, involving a debt-funded purchase, a few years of restructuring and a fairly quick exit, is tough to replicate in a capital-intensive industry known for its balance sheet woe, regulatory uncertainty and political pressure. Past experience is mixed. JC Flowers turned round Japan's Shinsei Bank, but TPG lost $1.3-billion (U.S.) investing in Washington Mutual.

The attraction for private equity is that the RBS business, which has a book value of £1-billion ($1.59-billion), has healthy returns. If results for the first nine months are annualized, it could make net income of £250-million, equivalent to a 25 per cent return on equity. If a buyer acquires it at a discount (Co-op recently bought a group of branches from Lloyds Banking Group at 0.5 times book value), returns look even better. Profitability might be lower in private equity hands given the need for IT investment and the loss of RBS's economies of scale, but the returns still look good.

There are obstacles. First, a private-equity buyer would have to convince regulators that it is a suitable owner and is able to inject more capital if needed. And the exit route is unclear. The big four U.K. banks are unlikely buyers, and Santander pulled out of a £1.6-billion deal to buy the business. That leaves private equity hoping for an upturn either in the economy, which would attract an overseas bank buyer, or in the IPO market. If either happens and the business can be sold for book value, there will be a pot of gold for the private equity group willing to take the risk. It might be a long wait.

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