Royal Bank of Scotland:Inside the Bank that ran out of money

The Royal Bank of Scotland (RBS) is one of the biggest banks in the world. In the 90’s, Sir Fred Goodwin is the chief executive officer of RBS and he lead RBS to became one of the bank that has rapid growth among other banks. How did Sir Fred Goodwin do it? Under the lead of Fred Goodwin, he started by merge and acquisition. In order to make the financial growth of RBS increase, Fred Goodwin plans to takeover other banks in the market. First, Fred Goodwin plans to takeover NatWest which is a bank that is located at United Kingdom. The reason why Fred makes that decision is because that NatWest Bank has a big building but with a very poor finance growth and the share price is low as well. After Fred takeover NatWest, RBS make a large profit over the year and Fred decided to reinvest those profits into different assets.  Well, some people think that Fred Goodwin is a megalomaniac because he pursues the size more than shareholder value. Do you agree with that? In my point of view, Sir Fred Goodwin is overconfidence with the decision that he made. Is taking over other bank a good way to build up the name of the bank? If yes, why do Sir Fred Goodwin almost cause RBS collapsed in the end?

                In the early 2006, USA has a property booming where Fred Goodwin thinks that there is a big money could be made. RBS has merged with a bank in USA which is known as Charter One. By that time, banks started to make loans like prime and subprime loan to borrowers. By making loans like subprime lending, the bank can make a lot of money as long as borrowers repay their loan. However, it is a high risk high return investment because the bank lend loans to people who might not have enough of ability to repay back their loan and so the interest rate are high as well. Unfortunately, the property bubble burst in the late 2006. Many borrowers cannot afford to pay back their loan and so they stop paying it and declare themselves to bankruptcy. Banks that do a lot of subprime loan are facing heavy losses as well and the market is in recession. In this case, RBS is also affected by the subprime crisis due to the merge with Charter One in USA. I personally think that merge and acquisition with other banks is benefit to the company. However, if a bank takeover too many banks, it will cause a burden to itself because it needs a lot of capital to takeover a bank each time. By that time, RBS had a press conference to assure to the city that the subprime amount that they do is very small which will not affect the bank. But, how could a bank manage to grow well if the economy is in recession condition?

                In 2007, RBS plan to takeover a Dutch Bank known as ABN AMRO. Sir Fred Goodwin thinks that this bank has a good potential in future because it has many good business, good attractive and good views. At that time, many risk analyst and investors are disagree with what Fred plan to do because that think that his decision is insane even after ABN AMRO announced that they sold off LA SALLE in USA. In my opinion, the reason why I think Fred Goodwin is overconfidence is because he thought he could make profit after takeover ABN AMRO like how he takeover NatWest in the past. In addition of that, I think that Fred Goodwin did not do enough of background research of ABN AMRO where he should go through the due diligence process before he decide to take over the bank. Besides that, I think Fred Goodwin had made a very serious mistake by taking the bank reserves to purchase ABN AMRO. If a bank runs out of money, it is because that it does not have enough of bank reserves in the bank. But why Fred Goodwin wanted to make this decision even he knows the risk of it? In September, subprime crisis is fully spread and the market went into turmoil. By this time, RBS realised that it is a wrong move to purchase ABN AMRO because it contained exposure of £100mil of subprime related investment. In December 2007, RBS announced that they have suffered deep losses of £1.5 billion. The RBS core equity 1 ratio is getting dangerously low and RBS force to ask for more cash from shareholders. However, shareholders are angry with what Fred Goodwin’s decision and they do not trust RBS anymore. RBS started to run out of option and the cash reserve drained on ABN AMRO followed by the decrease of share price. By that time, no banks are willing to lend money to RBS. Lastly, RBS ran out of money and the government has to help RBS from the deep losses. Therefore, do you think that Sir Fred Goodwin is a smart CEO? If he could be a bit more careful and concern more about shareholder’s value then RBS might not have to face such deep losses. 

Stock Market Efficiency Vs Behavioral Finance

According to Investopedia, behavioral finance can be defined as a study of investor market behavior that derives from psychological principles of decision making and explain the human decision making in buying or selling the stocks. There are some errors that are always made by investors such as overconfidence, confirmation bias, conservatism and so on. Therefore, I believed that not all investor can think rationally when they are making decision in buying or selling stock.

Meanwhile, Stock Market Efficiency is known as the stock prices that will reflect on all available information in the market and the stock prices will only changes when there is new information enters to the market. So, there is no way that investors can make extra profits by doing analysis in the market because all available information is already reflecting into the stock prices. According to Fama (1970), there are 3 forms of market efficiency which are weak from, semi-strong and strong form.  But today, I will just talk about the semi-strong form and strong form efficiency. Is there any relationship between stock market efficiency and behavioral finance? In my point of view, I believe that every person will have a strong desire for more wealth that will cause us cannot make decision in a rational way. Therefore, investors will make decision if there is any news or rumours is spread in the market. This also explain that why there is no systematic link between one price movement and subsequent ones and share price changes when new news enter to the market.

Recently, I have just read this interesting news which talks about the United Continental (UAL) chief in hospital after heart attack from the BBC headlines one day ago. Oscar Munoz, the new CEO suffered from a heart attack on Thursday. After the news announced, the shares price of UAL fell from $57.89 to $55.97. It shows that there is semi-strong form efficiency because the share price had reacted quickly and rationally to the latest information from United Continental Airlines. After the announcement, some investors might react quickly to sell off the UAL that cause the price of shares dropped. According to Wall Street Journal, it reported that the company’s board still waiting to know the latest news from doctors and Munoz’s family about health condition of Mr. Munoz before making a decision on whether a permanent chief executive is needed or not. If this news is announced then will this cause the share price drop again?

Date	Open	High	Low	Close	Volume	Adj Close
16/10/2015	57.89	57.98	55.05	55.97	14537200	55.97
15/10/2015	57.79	58.08	56.72	57.76	4170200	57.76

For more information, please go to: http://finance.yahoo.com/echarts?s=UAL+Interactive#{"range":"5d","showPrePost":false,"didDisablePrePost":true,"allowChartStacking":true}

Digby Jones: The New Troubleshooter (Episode 1)

Lord Digby Jones is a person who is born into business and his mission is to turn survival into success and protect the future of the workforce. In the title of Digby Jones: The new troubleshooter, he will be facing different kind of challenges in 3 different sectors which are the furniture, textiles and electronics company. However, I only managed to watch on of the episode which is episode 1: Hereford furniture.  In this episode, Hereford furniture is a family-owned company with over 40 employees working in this company. Mike Muxworthy is the managing director and his daughter, Kate Muxworthy is the sales and marketing manager in this company. In United Kingdom, Recently, Mike had made a loss of £80k in his business last year and he is searching for advice from Digby Jones. In order to help Hereford furniture to survive, Mike has to take some risk in changing his company policy. By taking high risk, high return is what Mike should do now to turn his company from survive into success. By doing this, he has to make few changes which are very important to him and his company.  

          First, Digby meets the heart of the business which is those employees that work in Hereford furniture. From there, he gets to know that the 40 employees are working at their own job and no one work as a whole together. In my point of view, I could see that there is a lack of communication skills between those workers and it causes the production become inefficient enough. The production inefficiency are mainly because that every workers are only concentrate in doing their own parts and did not participate in other worker’s job. Besides that, Digby doubt that whether Mike is able to handle three divisions in one company. It is good that Mike had that idea of importing products from China, manufacture it and start his own retail shop to sell his furniture to the final customer. By doing this, Mike can import best quality products from China and manufacture it as his own brand name. This might help Mike to create value on his product. However, I disagree with Mike’s decision. Digby thinks that Hereford furniture is just a medium sized company where it is difficult for Mike to be expert in handling all three divisions at all time. Mike’s idea might be good if Hereford furniture is a large sized company such as IKEA. In my point of view, I think Mike is not focus enough if he handles three divisions in a medium sized company and there is not enough of specialist to help him as well. Meanwhile, Mike had also come out with a very large production range in furniture because he hopes that his customer can get whatever they want in Hereford furniture. But this decision is slowly killing his business. From what I have learned in the week 2 lecture class, I think that Mike should divest his assets from negative spread units to release capital for more productive use. In order to create value for the company, Mike can choose to reduce his production range and try to focus in what customer demand in the market. I personally think that a company that has various type of product for customer to choose is a good decision but this does not apply to all company because not all company have the huge capital to cover those losses if those product are not able to sell it out like Hereford furniture.

Other than that, I realized that the designs of furniture from Hereford furniture are too simple and boring which is also mentioned by Digby Jones. In this case, Digby bring Mike to Emma Bridgewater which is a very famous company in United Kingdom just to prove that whether the brand name of Hereford by Design is attractive enough to attracts the customers in the market. However, the brand name is not strong enough to get customer’s attraction and so Kate and her shareholder come out with a new brand name that called “Hygge”. This word does not exist in the dictionary because it is a Danish word where they think that it could attracts customer’s attention. In my point of view, people will always have the curiosity about things that they never seen or heard before. Therefore, I believe a brand name like “Hygge” is attractive enough to get customer’s attention where it is also a kind of strategy to create value for the company. Moreover, Digby wants Mike to prepare a cash flow forecast to support the product range reduction which Mike could not see any benefit of doing it. In this case, I personally think that preparing a cash flow statement and balance sheet in every end of the month is very important to a company because we can know how much profit we earned and what is problem that causes a company making a loss.

In conclusion, I was impressed by Digby Jones of how he changes the fortune of a medium sized company like “Hereford furniture and the way that he solves the problems and talk to everyone in a smart and polite way. In five months’ time, he could manage to help Mike to make some changes in the future of the business. Mike had also understood that in order to save his company, he will have to take a big step forward and to change his style and everything. I believe that Hereford furniture will have a bright future if Mike could overcome those problems that are pointed out by Digby Jones. As what Digby Jones said, “Failure is always not an option”.