RBS: Getting Stronger by Raising Equity

Even by this month's outsize standards, the $24 billion that RBS is raising in new capital is an absolutely enormous sum. But it's much more than a replenishment, it's a significant augmentation:

"In the light of developments during March -- including the severe and increasing deterioration in credit market conditions, the worsening economic outlook and the increased likelihood that credit markets could remain difficult for some time -- the board has concluded that it is now appropriate for RBS to accelerate its plans to increase its capital ratios and to move to a higher target range to reflect the generally weakened business environment," the bank said in a statement

...The rights issue and disposals together are expected to bring Royal Bank of Scotland's ratio of capital against risky assets, also known as the core tier 1 ratio, up to an estimated 6% at the end of June this year from 4.5% at the end of 2007. Regulation calls for core capital to cover 4% of risk-weighted assets.

CEO Fred Goodwin is giving himself a nice capital cushion here, allowing him to continue to take the kind of risks he loves - maybe even a well-timed acquisition, if something attractive comes along. But it's also clear that buying ABN Amro (ABN) at the top of the market does look, in hindsight, to have been extremely expensive. And Goodwin's probably quite relieved at this point that he ended up losing LaSalle to Bank of America (BAC).

Given how expensive equity is these days, why is Goodwin still paying out a $4.5 billion dividend? Remember this is a rights issue, so it's mostly just a case of giving to shareholders with one hand while taking back from them with the other. Maybe Goodwin got Goldman, Merrill, and UBS to charge him a very low fee for underwriting the issue, so he just wanted to make it as big as possible and get it all over and done with in one go.

Overall, this might not be great news for RBS shareholders in the short term - the stock opened down about 4% on the news - but it's good news for the UK and even the global financial system in the medium term. Right now, it's good to have too much capital, rather than just enough. Would that more institutions followed suit.

Comments

[weiwentg]

4.5% tier 1 equity sounds dangerously low in this market to me, especially given that other US banks have been raising equity when their tier 1 ratios were in the 7.5% region.

Morningstar's latest analyst report on Bank of America said that they'd be more comfortable if BAC's ratio were 8%; it's now 7.5%. BAC is a much stronger company than RBS.

So, good for Fred that he's raising capital, and maybe good for banks in the rest of the UK. But RBS took a step too far and is now paying for this. If I were a major shareholder, I'd be thinking about asking the CEO to resign, or trying to vote some of the board members out.

[venividivici]

Why any sensible investor would have anything to do with any of these utterly discredited banks and investment banks is totally beyond me.
The overall performance of management has been characterized by obscene greed and idiocy and yet you keep on pumping up people like Goodwin.

[chrism1962]

RBS also intends to sell its non core insurance companies, raising around $8 Billion in the process. Angel Train Leasing may also be sold, raising another potential $4 Billion.

It is looking to beef up the balance sheet to cope with further write downs during the rest of the year, which are now coming to light.

Recapitalisation is the correct way to go, but the share price will continue to drop, as the discounted rights issue is priced at 2.00 pounds per share, the shares may drop as low as 2.30, until the rights have been purchased and sold on.