Royal Bank Finally Bites The Bullet
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The second worst kept secret of the last seven days was finally revealed today as Royal Bank of Scotland
(LSE: RBS)
unleashed Europe's biggest-ever rights issue.
Royal Bank of Scotland is raising a net £12bn to help shore up its subprime-ravaged balance sheet, while ‘fessing up to a further write-down of £5.9bn and a 2008 payout cut.
The big issues now facing investors are...
Is the bad news now ‘in the price', or has RBS further to fall?
And should shareholders take up their rights?
Before addressing those thorny questions, here's some background..
A rights issue enables a company to refill its coffers by selling extra shares to stockholders, whose incentive for stumping up is the right to buy these new shares at a discount.
No doubt some shareholders will want to take the opportunity to invest fresh cash into RBS.
However, if a shareholder doesn't want to invest any fresh cash, he can sell his new shares in 'nil paid' form. In other words, he sells the new shares after they have been created - when they go 'ex-rights' - but before they have to be paid for. Of course, if he does sell the new shares, his remaining interest in the company has been significantly diluted.
RBS is offering 11 new shares for every 18 existing shares at an issue price of 200p a shot. Based on the stock price of 358p at 9.30am today, that works out at a current discount of 44%, and a 33% discount to the theoretical ‘ex-rights' price of 298p.
The stock market being disinclined to hand out free lunches, the price of the old shares automatically adjusts downwards on ‘ex-rights' day. ‘Nil paid' trading is expected to start in mid-May, with dealings in new ‘fully paid' shares kicking off in June.
What's the picture now for RBS?
The bank has made several recent errors, including the top whack €72bn paid by its consortium for ABN Amro last year.
It's also had to mark downs its assets today by £5.9bn following the £2.4bn hit already incurred in February. With that background, RBS has chosen now to take the plunge in rebuilding its capital ratios.
The bank is also looking to raise £4bn from disposals of units like insurance, which includes the Direct Line and Churchill brands, although "undervalued" assets won't be dumped in a "fire sale".
More investment banking jobs are being chopped than initially expected. And shareholders will also share the pain as the current year dividend will be cut by an unspecified amount.
So what of the future?
Despite the predictable official expression of confidence in the ability of the executive team, the outlook is "inevitably clouded" by US subprime mortgage turmoil.
And financial watchdog Moody's suggested today that a combo of concerns over volatile capital markets, the size of the write-downs, the integration of ABN Amro and more UK economic risk may force a downgrade of the bank's debt ratings.
That doesn't breed too much confidence that there won't be more skeletons to emerge from the parlour.
As for the share price...it's stating the bleedin' obvious, but with a 61% increase in the number of shares in issue, there's unlikely to be a stock shortage in the near future.
Bank of England Governor Mervyn King has already endorsed bank rights issues, and expects to see others.
Which probably means much more money being sought by indigent lenders, plenty more shares sloshing around for investors to absorb, and a recipe for lower prices.
For shareholders, taking up the offer makes a lot of sense if you think the credit crisis is nearly over.
However, I'm pessimistic. I believe there's still a long way to go before financial markets are out of the woods. I'd be selling the ‘nil paid' rights.
More: Bail Out Monday | What Is A Rights Issue?
