The Royal Bank of Scotland's big plan not to split off its toxic assets into a "bad bank" last night earned it a credit rating downgrade from Standard & Poor's.
Shares in RBS fell last week after it said it would retain the poor assets internally but S&P was the first ratings giant to downgrade its creditworthiness. The agency warned the RBS decision would mean it will take even longer for the bank to detoxify itself, while a second strut of the plan – to accelerate the sale of its higher-risk assets – was also a worry.
"In our view, these changes create additional near-term execution risks and further delay the group's return to sustainable organic capital build," S&P said.
RBS said it was "disappointed" at the downgrade but added that other agencies had not taken such a dim view. Such downgrades generally make it more expensive for companies to borrow, but RBS said the S&P move should not have a "material" impact.
The downgrade reversed a "positive transition notch" S&P had given the bank in 2011. As well as the decision not to opt for the good bank-bad bank option, S&P blamed the high risk of being sued. That was a timely warning, given that it came just as RBS's enthusiasm for selling investors toxic subprime mortgage bonds in 2007 cost it $153.7m (£95.6m) in a US out-of-court settlement.
RBS did not admit guilt but agreed to pay the cash to the Securities and Exchange Commission. The watchdog was suing because RBS allegedly misled investors about the quality of $2.2bn of sub-prime mortgage-related investments it sold them.
The bank had promised that the mortgages backing the investments "generally" met its safety standards.
However, the SEC's lawsuit said: "In fact, RBS knew or should have known at the time that almost 30 per cent of the loans backing the offering deviated so much from the lender's underwriting guidelines that they should have been kicked out of the offering entirely."
The SEC said RBS pocketed about $4.4m in fees for underwriting the sale. It rushed it through because the client had set a tight deadline.
"RBS cut corners and failed to complete adequate due diligence, with predictable results," said George Canellos, co-director of the SEC's enforcement division.
The watchdog said the bank hired an outside consultant quickly to examine a small sample of the assets it was selling. That due diligence exercise highlighted that a large number were too risky for the bank's guidelines. While it took out the toxic loans in the sample, it did not examine the remaining assets.
Furthermore, the bank insisted the due diligence firm changed its prudent policy of putting first-time buyers in the high-risk category. This clearly irritated the due diligence contractor, who emailed: "You like it when I'm fired up, do you? cause I'm p!ssed right now." He later added: "I'm kicking out FTHBs [first time homebuyers] like they had smallpox over here."
Once the investors had bought the assets, they proved extremely toxic, plummeting in value by $80m. The SEC lawsuit states that RBS's credit division had wanted to do further due diligence but the lead banker on the deal wanted to press on, saying further checks could "blow up this trade".
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