RBS wants £10bn
A chill blast hit me as soon as I stepped off the plane last night at the end of a short holiday in a place where the skies are mostly blue. Yesterday's leak (to BreakingViews) that RBS is contemplating a massive rights issue marks a new and important British phase in the credit-market turmoil that has been shaking the global economy since last summer.
What I have learned is that:
1) Royal Bank will ask its shareholders for around £10bn, equivalent to a bit less than a third of the bank's current market value.
2) Following the leak, the formal announcement will probably come on Monday or Tuesday, a bit earlier than planned.
3) It will ruthlessly write down its exposure to US subprime and any other potential credit nasty. There will be billions of pounds of additional write-downs.
So let's unpack those startling facts. RBS will be severe in marking down the value of its exposure to subprime (about time too, some would say). It will feel obliged to do this, to provide comfort to shareholders that when they stump up the precious £10bn in new capital they won't be throwing good money after bad: investors will want some kind of guarantee they won't face the kind of pain experienced by those who last year injected capital into overseas banks such as Merrill Lynch and UBS.
That said, those subprime losses will be an embarrassment for the bank, not a mortal blow.
There is no liquidity problem at RBS. It is in a relatively strong position in respect of its access to short term funding, both from customers/counterparties and also from central banks (as a big international business, it can for example access all the funds it needs from the European Central Bank).
Nor is it perilously short of capital. It isn't bust.
And what RBS has noticed is that the regulatory climate has changed, in that both the government and the Financial Services Authority have been sending out clear unambiguous signals that they want banks to raise as much capital as possible.
It's the quid pro quo for the Bank of England's new scheme to pump money into the banking system, which would provide tradable government securities of two or three-year maturity in return for the unsellable and unfinancable mortgage assets that have drained liquidity from the banking system.
The formal launch of the Bank's latest initiative to bring down the market price of money and ease the funding difficulties of smaller banks is still days away. However, it will involve increased exposure for taxpayers to our banks, so it's unsurprising that the Treasury should feel that the banks' shareholders should also do their bit - and RBS has decided that it will ask its owners to divvy up first.
Make no mistake, this will require a bit of explaining from Sir Fred Goodwin, RBS's chief executive. For years he has argued that it was in shareholders' interests for his bank to operate with significantly less capital than many of its peers. Some will see the rights issue as a humiliating U-turn for him - and the further losses that the bank will announce from its subprime exposure won't be a reputation enhancer.
How big will those losses be? Well, last year it suffered £2.6bn of write-downs on its own exposure and what it inherited from the ABN takeover. But that subprime is being carried on its balance sheet at values way above the valuations put on this poisonous stuff by leading US banks.
As we saw from Merrill Lynch's horrendous figures a few days ago, the price of investments linked to subprime and other mortgage assets is still falling.
What's some cause for concern is that some 48% of RBS's so-called high-grade subprime CDO exposure was originated in the nightmare year of 2007, while 69% of its lower grade mezzanine exposure was created in the other annus horribilis, 2006.
So no-one should be surprised if RBS incremental subprime losses turned out to be more than they were in 2007, viz at least £2.6bn - and possibly a good deal more.
Is there any comfort for Sir Fred? Only that as and when he gets his bumper rights issue away, the heat will then be on RBS arch rival, Barclays, to disclose whether it too has suffered serious additional subprime losses.
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