RBS gets out the begging bowl

It's been a busy week for the banking sector. The Bank of England launched a massive support operation for banks in an attempt to alleviate the liquidity squeeze and unclog the mortgage markets. The next day, Royal Bank of Scotland (RBS) launched the biggest rights issue in British corporate history. It will sell £12bn of new shares at a 46% discount to Monday's closing price and further shore up its capital base to the tune of £4bn by selling off assets, including its Direct Line and Churchill insurance business.

Royal Bank of Scotland also wrote down £5.9bn, due to losses from US mortgages, leveraged loans and monoline insurers, and looks set to post a loss in the first half. Meanwhile, the interim dividend will be paid in stock, which implies a cut, given the huge issue of new shares.

RBS's screeching U-turn

"It is virtually unheard of for such a complete volte-face to occur in such a short space of time," said Jeremy Warner in The Independent. Less than two months ago, chief executive Sir Fred Goodwin was so bullish about the group's earnings outlook and capital strength that he announced a 10% rise in the dividend. RBS didn't foresee quite how rapidly the economic outlook and credit conditions would deteriorate.

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The basic problem, as Lex pointed out in the FT, is that RBS "has been riding a bull market balance sheet", with a thin capital cushion and leverage, for a long time; its cash acquisition of ABN Amro took it to "breaking point". Its weak core Tier 1 ratio a gauge of financial strength should now rise from a lowly 4% to 6%. If markets normalise, the bank is "probably fine. But a prolonged slump would be a different matter."

This amounts to a "humiliating rescue" for RBS, said David Wighton in The Times, and shareholders and pension funds will suffer because of Sir Fred's "misadventures" in US mortgage assets and his overpaying for ABN Amro. Having all but ruled out acquisitions a year ago, he promptly piled into the ABN fight, letting his "animal spirits" get the better of him. As soon as a "decent replacement" is available, he should go.

What next

Following RBS's cash call, the spotlight has fallen on its rivals. On the write-downs front, RBS has applied conservative valuations to its assets, reducing Alt-A holdings (a step above subprime) to 50% of their original value. HBoS hasn't yet marked down its £7bn Alt-A holdings, while RBS's valuations imply a £6-7bn writedown at Barclays, reckoned Collins Stewart.

With further credit write-downs looming and the UK economy deteriorating, more rights issues look likely, especially now that RBS has taken the plunge and absorbed plenty of flak. As JPMorgan said this week, "lack of capital in UK banks is a systemic issue, not only an RBS-specific one".