Last week, the Royal Bank of Scotland (RBS) announced its record £12bn rights issue.
That’s a huge amount of money. It’s so large that it’s tough to get a handle on just how much money it is. Let’s just say that if a company with a market capitalization of £12bn was added to the FTSE 100 this morning, it’d slot in somewhere around the top 30, near Cadbury Schweppes and Scottish & Southern Water.
In that light, the reaction to the fundraising so far has been pretty positive. It won’t feel like that to the chairman Sir Tom McKillop, nor chief executive Sir Fred Goodwin, but they can’t expect an easy ride, and to be fair, no one’s lost their job yet.
Moreover, the market seems to have welcomed the idea that at least the bank might be drawing a line beneath its problems. Uncertainty is something the market can’t bear, so the prospect of some stability makes even £12bn seem a price worth paying.
But now that RBS has given the green light to fund raising, who’s next?
Barclays has no plans for a rights issue
After RBS had broken the ice by going to its shareholders with the begging bowl, many were expecting its rivals to line up to do the same.
However, Barclays, which was seen as a prime candidate, seems to have decided to brazen out the credit crunch. Last week it said it had no plans for a rights issue, though it didn’t rule one out. This looks like a potentially risky strategy. As Robert Peston reported on the BBC last week, the investment banking arm, Barclays’ Capital. “has substantial exposure to sub-prime, CDOs, monolines, loans to private equity” and all the other stuff that hurt RBS. But as Peston also suggests, perhaps Barclays’ risk management systems were better.
And perhaps, more to the point, what Barclays didn’t have, was ABN Amro, which was the straw that broke RBS’s back. Chief executive John Varley no doubt felt more than a moment of pleasure at RBS’s expense when he told shareholders that Barclays – which lost a hard-fought bidding battle for the Dutch bank – was right not to overpay for the group.
But after talking up expectations, it will now be much harder to justify a rights issue at a later date. That suggests that Barclays would be more likely to raise money from sovereign wealth funds if it ends up needing it. That at least would enable it to avoid the kind of embarrassment that the top brass at RBS have had to endure. It may seem a small price to pay after the mess they’ve made, but being humiliated in front of a room full of small shareholders isn’t something that any one would enjoy. For a ‘Master of the Universe’ it must be particularly unwelcome.
So if not Barclays, then who? The next in line seems to be HBoS. Reports in The Sunday Times and The Sunday Telegraph suggest that it may be looking to raise another £2bn to £4bn, though the bank has yet to comment. It’s also expected to write down up to £3bn on subprime-related assets. The group has £6.6bn in CDOs built from asset-backed securities, and a further £7bn in Alt-A (not quite as bad as sub-prime, but far from prime) mortgages, which have continued to fall in value along with US houses.
As George Hay points out on Breakingviews, RBS only had £3.8bn in CDOs and £2.2bn in Alt-A. RBS is now valuing its CDOs at half their face value, and its Alt-A portfolio has been written down by a third, though the FT reports analysts as saying that HBoS’s Alt-A portfolio is better protected and higher quality than its rival’s.
HBoS could always get away with trying to simply tough it out, like Barclays. Both banks are better capitalized than RBS. RBS had by far the lowest Tier 1 capital ratio of the banking sector (banks need to make sure that they retain sufficient funds as a proportion of their ‘risk-weighted assets’ – lending, in other words – to act as a cushion). Before it raised money, RBS’s core Tier 1 capital ratio was just above 4%, according to Morgan Stanley, whereas Barclays’ is 5.1% and HBoS’s 5.7%. But with RBS now aiming to raise its ratio to 6%, that puts a bit of pressure on the other two to up their game as well.
Falling UK property prices is the biggest issue for HBoS
That’s not the real problem though. The biggest issue for HBoS isn’t so much the US housing market. It’s the UK’s. HBoS has a 20% share of the UK mortgage market, making it the market leader. When house prices are falling, that’s not a great place to be. Under the ‘Basel 2’ banking rules, as assets become riskier, you need to hold more capital against them. If house prices are falling, that makes home loans riskier (a loan against 90% of a home’s value is clearly riskier than one against 60% of a home’s value). So that impacts on the tier 1 capital ratio.
Halifax itself has already forecast that house prices are likely to fall this year, but it’s still being too optimistic, expecting a low-single digits fall. Its own house price index showed that in March 2008, prices were down on March 2007, but because it uses three-monthly figures in the annual comparison, official prices were still slightly higher year-on-year.
But this morning, the first set of house price figures to show an official annual decline in house prices have been released. Property group Hometrack reports that house prices fell 0.6% in April, and were down 0.9% on last year. The average time to sell has risen from 8.5 weeks to 9.1 weeks, and homes are fetching 93% of asking price, from 93.5% last month.
It seems that HBoS still hasn’t made up its mind about whether to go for the rights issue or not – we’ll no doubt find out tomorrow. But to my mind it’s the perfect time to do it. Banking investors are hoping that the worst is over. And there’s enough residual optimism remaining in the housing market so that people can still kid themselves that it won’t be as bad as the 1990s. HBoS should take advantage of that and shore itself up before it becomes plain that the outlook for the UK economy is much worse than anyone yet expects. It may not get another chance this good.
Turning to the wider markets…
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On Friday, the FTSE 100 closed 40 points higher at 6,091. Financial stocks were among the main risers as in the US, Merrill Lynch said it would maintain its quarterly dividend.
Across the Channel, the Paris CAC-40 rose 48 points to end the day at 4,978. And in Frankfurt, the DAX-30 gained 75 points to 6,896.
On Wall Street, US stocks were mixed. The Dow Jones rose 42 points to end at 12,891. The broader S&P 500 gained 9 points to end the day at 1,397, while the tech-heavy Nasdaq slipped 6 points to close at 2,422.
In Asia this morning, Japanese stocks nudged higher. The Nikkei 225 gained 30 points to 13,894.
Crude oil hit a record this morning, trading at near $120 a barrel, amid the Grangemouth refinery strike, and attacks in Nigeria. Crude was trading at around $119.21 in New York. Meanwhile Brent spot was trading at $116.97.
Spot gold was trading at around $893 an ounce this morning, while silver was trading at $17.01. Platinum hovered around $1,971.
Turning to forex, sterling was trading at 1.9799 against the dollar, and at 1.2653 against the euro. The dollar was last trading at 0.6392 against the euro and 104.5 against the Japanese yen.
And this morning, Reuters reports that Sainsbury’s says it was visited by officials from the Office of Fair Trading as part of a wide-ranging probe into grocery prices. The Competition Commission is due to publish details of a two-year inquiry into the grocery market by May 8.
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