RBS rights issue: a sign of the times
On 22 April 2008, the Royal Bank of Scotland (RBS) announced a rights issue to raise £12 billion (net of expenses) to increase its capital base, the largest ever rights issue in Europe (see box “Key terms”).
While the RBS issue is noteworthy because of its sheer size, RBS is just one of several groups to announce rights issues in recent months. In April 2008 alone, there were announcements by UBS of a proposed £7.7 billion rights issue, HBOS of a £4 billion rights issue, Imperial Energy Corporation of a £306.7 million rights issue and Cattles of a £200 million rights issue.
More recently, Bradford & Bingley announced a proposed £300 million rights issue, and there has been wide media speculation that Barclays, RBS’s rival in last year’s takeover of ABN Amro, may need to take similar action to repair its capital position (see “Battle of the Banks: RBS wins ABN Amro”, www.practicallaw.com/0-381-3289).
Reasons for the RBS offering
RBS says that it decided to accelerate its plans to increase its tier 1 capital ratios and to move to a higher capital target range to reflect the generally weakened economic environment.
The acquisition of ABN Amro and write-downs of £2.5 billion in 2007 due to credit market exposure, left RBS one of the most highly-leveraged banks in Europe. The bank estimates continuing credit market exposures could lead to £4.3 billion (net of tax) in additional write-downs in 2008.
“The RBS Board has been very upfront with shareholders in addressing its capital planning issues and credit market exposures,” says Robert Elliott, a partner at Linklaters LLP, who advised RBS on the offering. “Instead of taking half measures, the Board decided that a rights issue would be the fastest and most effective way to resolve the bank’s capital position.”
The bank also plans to dispose of certain non-core assets as part of its capital management plan, including its insurance business which includes household names Churchill and Direct Line.
The RBS rights issue is being made on the basis of 11 new shares for every existing 18 shares, at 200 pence per share. This price represents a discount of 39.4% on the theoretical ex-rights share price (the level to which the stock is expected to fall once the new equity is issued) and 46.3% on the closing price of 372.5 of 21 April 2008, the last day of trading before the announcement.
Goldman Sachs, Merrill Lynch and RBS are acting as joint bookrunners to the rights issue and UBS is acting as co-bookrunner. The rights issue is fully underwritten by Goldman Sachs, Merrill Lynch and UBS.
At an extraordinary general meeting (EGM) held in Edinburgh on 14 May 2008, shareholders voted to approve the offering. Dealings in new shares, nil paid, on the London Stock Exchange began the following day. The last date for acceptance of the provisional allotment letters is 6 June 2008.
Given the background of the credit crunch, potential risk factors (from continuing credit market dislocation to possible litigation) needed to be disclosed with unprecedented clarity and detail in the prospectus.
Impact on shareholders
Shareholders now have three options: exercise their rights and buy the new shares, sell the rights on the open market, or do nothing in which case their rights are placed by the underwriters and proceeds passed on to the company.
A rights issue is generally demanding on shareholders. If they do not take up the rights, they risk diluting their proportionate ownership in the bank.
In addition to coming up with the cash to maintain their stake, some shareholders are also concerned about the future payment of dividends. RBS has already said the interim dividend will be paid in shares, not cash. The end of year dividend will be cash, and even though RBS has signalled its intention to pay 45% of its underlying earnings to fund the dividend, with an extra six billion shares in issue, the payout is likely to drop.
Unsurprisingly, the offering has received a mixed response from shareholders, as has been the case for most groups taking such action. “How the rationale behind the move is explained to shareholders is critical,” says Elliott. “These factors can strongly affect shareholder sentiment.”
Only the beginning
In recent years, rights issues were uncommon because debt was cheap and readily available, so companies needing cash preferred to borrow. However, the credit crunch has turned the tables, and raising equity has become a priority for many cash-strapped banks.
“This spate of capital raising is likely to continue, at least over the near term. At the moment, there seems to be adequate funding available in the market,” says Elliott.
Citi (formerly Citigroup) currently leads the charge, having raised over $40 billion since November 2007, when it began raising capital with a private placement of $7.5 billion worth of common shares to the Abu Dhabi Investment Authority. Citi then raised $12.5 billion through the sale of convertible preferred securities, with the remaining equity being raised through offerings of preferred stock and common stock, the most recent of which took place in April 2008.
The most appropriate method of raising equity depends on the circumstances of the issuer, including the amount of capital and the timeframe in which it is required.
A placing or open offer has the benefit of raising capital more quickly than a rights issue, because a rights issue may require shareholder approval at an EGM (see box “Key terms”). In addition, the uncertainty around whether the rights issue will complete can cause significant fluctuations in the issuer’s share price.
However, the amount of capital that can be raised in a placing or open offer is usually limited to 5% of issued share capital because of investor protection committee guidelines on non-pre-emptive issues. Where a company wants to do a larger issue, a cash box structure can be used.
Under a cash box structure, shares are issued otherwise than for cash, to circumvent pre-emption rights (for background, see “Cash box structures: uses and implications”, www.practicallaw.com/6-102-8458).
Cash box structures are more usually seen in the context of acquisitions and they are not without their risks, but the market’s current hunger for cash could see them emerge as a rights issue alternative.
Alarna Carlsson-Sweeny, PLC.
The essential aspects of a rights issue include:
An offer of new shares or other securities;
Made (broadly) to existing shareholders in proportion to their shareholdings;
To be subscribed in cash, nearly always at a discount to the market value; and
With the ability for the shareholder to realise the value of his rights to subscribe for the new shares (represented by a provisional allotment letter) by selling them in the market nil paid.
A placing is an issue of shares to a specific group of individuals (usually institutions). Statutory pre-emption rights will normally have to be disapplied to effect a placing. Investor Protection Committees impose strict limits on the number of shares that can be issued in this way and the value at which they can be issued.
An open offer is an offer of new shares usually at a discount to existing shareholders on a pre-emptive basis, similar to a rights issue. The usual practice is to invite shareholders to apply for any number of shares. Unlike a rights issue, application forms are used (instead of provisional allotment letters) which cannot be traded nil paid and no arrangements are made for the sale of shares not taken up by shareholders.