RBS can be privatised within a year, says the bank's chairman

Royal Bank of Scotland, the giant ailing bank 82% owned by taxpayers, is on the mend - if not quite mended.

For the first three months of the year, it made a profit at the operating level, before tax and after tax, which may be a unique occurrence since the crash of 2008.

And although its pre-tax profit of £826m is less than it ought to be generating on a quarterly basis, given the size of its balance sheet and market share, it is a considerable improvement on the £1.5bn loss it made for the comparable period last year.

There has even been a modest increase in its net lending to small businesses, after years of being criticised for shrinking this lending - which RBS's chairman Sir Philip Hampton attributes in part to the Bank of England's provision of cheap funds through the Funding for Lending Scheme.

So RBS believes that during the course of next year, it will have shed most of its toxic residual assets and will have completed its reconstruction.

This means, says Sir Philip, that as of the middle of next year - and possibly earlier - RBS will be in a fit enough state for the government to start selling its huge stake, to begin the process of privatisation (see him saying this here on the RBS website).

The unmissable implication is that Sir Philip would dearly love the government to do that.

What Sir Philip and his chief executive, Stephen Hester, can't control is what happens to RBS's share price - which will have a big bearing on whether the Chancellor, George Osborne, wants to start the privatisation.

The terrifying point for Mr Osborne is that if he sold the whole of taxpayers' stake in RBS right now, an eye-popping loss of £18bn would be generated for the state - and the loss would only be a bit less if measured by reference to the carrying value of the shares in the government's books, rather than what the Treasury, under the previous chancellor, Alistair Darling, actually paid for them.

Under pressure

One highly sensitive and contentious political and investment question is whether the prospects for taxpayers getting all their money back would be enhanced if the government took permanent ownership of RBS's residual stinky assets, ran them down over the next decade, and only privatised a completely cleaned up bank next year (see here for more on this).

Next month, Mr Osborne may come under pressure from the Parliamentary Commission for Banking Standards he created to break up RBS into such a so-called "good bank" and "bad bank". That may irk him because hitherto he has been keen not to keep on his books what remains of RBS's more poisonous assets, likely to have a written-down value of around £40bn by the end of the year.

But the outgoing Governor of the Bank of England, Sir Mervyn King, believes that such financial engineering would improve the prospects for what he sees as a liberation of RBS back into the private sector.

Sir Mervyn would also argue that so long as the Treasury kept RBS's stinkier assets long enough, and felt under no pressure to get rid of them in a fire sale, taxpayers would even end up (more than likely) making a profit on these putrid loans and investments.

UPDATE 11:05

So if the government were to start the unwieldy process of privatising RBS (which would almost certainly be the biggest privatisation in UK corporate history), what price would it need to receive for the shares to avoid a loss?

Unfortunately, this is not the easiest question to answer.

According to UKFI, which manages the government's stakes in the banks, the price actually paid by the Treasury for its 82% stake was 502p per share.

However the valuation in the government's books is 407p per share - a fairly chunky difference.

That lower "book" value captures a loss that the government has already absorbed on the investment: the loss is the difference between what the government paid for the shares and the market price of RBS on the days the then Chancellor, Alistair Darling, actually handed over the money for the shares.

But 407p isn't likely to be seen by the National Audit Office, the watchdog that is supposed to prevent the government wasting taxpayers' money, as the true book value of the government's stake.

That is because the 407p valuation is thought to include too low a valuation for something called the "dividend access share", which gives the government enhanced dividends compared with other shareholders and needs to be bought out by RBS prior to privatisation.

So if we are going on "true" book value, that could be as high as 440p.

Or to put it another way, George Osborne has a choice of three numbers for the price he would need to receive for RBS shares to prevent a loss for taxpayers, 407p, 440p and 502p.

Most investment purists would see the correct number as 502p.

If the chancellor were to ape the often cynical behaviour of big companies when faced with similar accounting dilemmas, he would probably choose the lowest possible price - of 407p.

So politics being what it is, I suspect he will claim success if he can get 440p.

All of which may seem a bit academic right now, with RBS shares massively underwater, as they say, at 290p. Or to put it another way, the notional loss for taxpayers today on their 82% stake in RBS is a maximum of £20bn and well over £10bn on any valuation.