Major changes are coming at troubled Ulster Bank. The institution, owned by Royal Bank of Scotland Group plc (NYSE:RBS) (LON:RBS), has been losing money hand over fist since the banking crisis first erupted in Ireland in 2008. Operating losses rose to £1.457 billion last year from £1.040 in 2012.

Ulster Bank

It’s well known that the Royal Bank of Scotland Group plc (NYSE:RBS) (LON:RBS) has set up an internal team to deal with the problem of the ailing bank, and it has now been revealed that RBS has been in talks with the government bodies and other banks for the past five months in an attempt to wring out a solution. RBS chief executive Ross McEwan met with minister for finance Michael Noonan during February and sources say that they discussed the idea of a ‘third’ bank.

What do you do with a problem like Ulster Bank?

Talks are at an early stage, but it appears that one option is some sort of merger with Permanent TSB Group (OTCMKTS:ILPMY), so says Merrion Capital analyst, Ciaran Callaghan:

‘While underlying trends in the core Ulster Bank continue to recover, we would not be surprised to see the bank seek to merge with other small players in the coming year as it seeks scale.’

Permanent TSB Group (OTCMKTS:ILPMY) is still 99.2% state owned, but it’s thought that the tie up could have involvement from private equity firms too. The bank has already had discussions with a number of private equity firms to fund a new venture in the republic.  Yet RBS says it’s still committed to the Irish market. Chief executive, Ross McEwan said:

‘Our customers in the island of Ireland need to know that we are committed to providing them with a great everyday banking service. We will finalise our plans in the coming months – but this is about a change in business strategy not a withdrawal from the market.’

Government support

Certainly, the government will be eager to ensure that Ulster Bank does not follow other institutions, such as Danske Bank A/S (CPH:DANSKE) (OTCMKTS:DNSKY) and ACC, and leave the Irish market. It needs a bank to remain to offer credible competition to Bank of Ireland (ADR) (NYSE:IRE) and Allied Irish Banks PLC (ADR) (OTCMKTS:AIBYY), and Mr. Noonan has already made mention of this ‘third’ banking force in interviews, specifically in Fine Gael’s annual meeting just last week:

‘I’m sending a signal out to the European banking system that a growing economy in Ireland has space for more banking activity and we would welcome them participating in Ireland by way of subsidiaries or by way of going into partnerships with some of our domestic banks,’ he said. ‘I don’t have a fully formed plan for a third banking force. That’s not the point. I’m signalling now in advance of the need for that kind of service and I’m hoping that will be taken up.’

Could a merger succeed?

If a merger of Ulster Bank and Permanent TSB Group (OTCMKTS:ILPMY) was to go ahead, it would fraught with risk. Both banks are heavily exposed to loss making tracker mortgages. Moreover, staff at Ulster Bank are acutely aware of the problems faced by the bank and are concerned about job security. The bank has been slow to reveal the impact of its plans on jobs and potential branch closures, leading to staff calls for action. The workers’ union, the Irish Bank Officials Association (IBOA) has expressed its concern and general secretary Larry Broderick said the union would be canvassing the view of employees over the next few weeks:

‘Staff as well as customers want to know what kind of Ulster Bank will exist in the future and what, if any, changes are likely to branches, structures and jobs. IBOA is prepared for a comprehensive engagement with Ulster Bank’s management – which from our perspective will seek to preserve as many jobs as possible.’

It’s not impossible to think that the result could be some form of industrial action, which could affect any plans for a merger. Another worry is the ECB’s Asset Quality Review later this year to assess the health of banks across the eurozone before it takes over as supervisor in November. There have been threats to shut down those that fail the tests. Daniele Nouy, who will head the eurozone’s new banking watchdog within the ECB, said:

‘We are going to do it the tough way. And that is the signal all of us need – the banks needed to get that signal, the financial markets need that signal and the citizens of Europe need to get that signal.’

If that happens, it’s not inconceivable to see Ulster Bank out of business before a merger even has a chance to get off the ground.