RBS issue must be on commercial terms

September 21, 2009

Britain’s state-controlled banks appear to be playing a game of tit-for-tat. Lloyds Banking Group last week admitted it was looking for ways to reduce its exposure to the government’s insurance scheme for toxic assets. Now it turns out that Royal Bank of Scotland is also sounding out investors about tweaking its own involvement in the scheme.

That is where the similarities end, however. RBS is being much less ambitious than Lloyds. It still wants the government to insure all of the assets it agreed to put into the scheme in the winter. It just wants to pay some of the premium in cash rather than its own equity. This may look a superficially attractive way to de-risk the tax-payer’s huge exposure to bank equity, but the government should think hard before accepting.

Unlike Lloyds, RBS is not proposing to scale back its use of the government’s asset protection scheme (APS). Instead, the Scottish bank is considering raising at least 3 billion pounds, about a tenth of its market value, from shareholders to help fund the 6.5 billion pounds it has agreed to pay (but not yet coughed up) in order to participate in the scheme.

When the APS was negotiated in February, RBS offered to pay this fee by issuing the government with `B’ shares that convert into ordinary stock at 50 pence. At the time, when RBS shares were changing hands at around 20 pence, that looked like a pretty good deal for the bank. But the recovery in RBS’s share price now means it can contemplate raising cash privately at a similar price.

The key question is how RBS’s fundraising is structured. The bank’s shareholders have given it the green light to issue up to two-thirds of its share capital, but any issue that involves selling more than 5 percent of its share capital must be offered to all shareholders, including the state.

In practice this means that the government, which already owns 75 percent of RBS, will have to decide whether or not to take up its rights. If it chose not to, the dilution from the rights issue and the reduced issue of `B’ shares would keep the government’s shareholding below 80 percent.

On the face of it, any move that replaced state funding with private capital should be welcomed. But it is also important that taxpayers do not lose out. UK Financial Investments, custodian of the government’s stake, should insist that it will only stand aside if a rights issue is priced at a modest discount to RBS’s share price, which on Monday already slipped almost 5 percent to 53.65 pence.

That will prevent its shareholding from being diluted unnecessarily.

The government should also not forget that the B shares it would be giving up would almost certainly be valued at more than 50 pence each. After all, they carry the right to a fixed 7 percent dividend while RBS ordinary shares are unlikely to pay a dividend for the foreseeable future. Arguably the state should be compensated for this loss in value in some way.

This might make the deal slightly less appealing from the perspective of RBS shareholders. But if they place such a premium on limiting state ownership, they should be happy to pay up.

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