The HBOS Rights Issue

A number of columnists have been talking a great deal of nonsense about this. Take for example Neil Collins in the 8 May Evening Standard, who says they are "offering new shares at a silly price". Another over-excited columnist (whose name escapes me) last week said, how could the FSA chase the rumour mongers that caused the price fall to 390p when the bank itself was valuing them at 275p.

Neil Collins Standard article

This would be true were it not for the fact the offer is only open to existing shareholders. In fact, with a little bit of thought, it is clear that the price that these additional shares are issued at is almost completely separate from the current or future price of shares.

Imagine for the sake of clarity, that there were only 100 shares, and Mr A owns 5 of them. After the issue there will be 140 shares, and he will own 7 of them. Still 5% of the Halifax - so no change there. He would have £5.50 less in his bank account, but on the other hand, HBOS's net assets have gone up - his share of which being £5.50. In short, he has been forced to lend them some money (not give - because he should receive the benefits when the HBOS put this money to work).

The bank cap is about £18 billion, and they are aiming to raise £4 billion. In other words, for each £4 of Halifax you own, they are asking you to put in another £1. They might have only needed the equivalent of 10p per share, so they could be selling the new shares at 5p each. That wouldn't mean that the fair market cap of the bank had suddenly sunk to 1% of its previous value - because these are not ordinary shares being traded on the open market.

Why price them so far below actual value? Well for one thing, they need to make sure that there is no argument that the shares are worth more than 275p. Effectively any shareholder who didn't take up the offer is going to have their holding drop by 29%. HBOS need to make sure that everyone considers that whether to put the money in to maintain the holding is a no brainer. Otherwise shareholders won't cough up, and they won't be able to sell the rights to someone else because the rights would have a negative value. For this reason it pays to make the nominal share price low compared to the real price. This should not be considered as implying a real price, and nor should it be seen as a bad thing for the existing shareholders.

That is not to say that there aren't a few warning signs. The first is that HBOS is looking for a big increase in its capital to maintain its business. Is this going to be expanding their operations, or is it merely about holding the line - and therefore we can expect a significant drop in profitability.

The second is that HBOS paid to have the rights issue underwritten - the implication being that they thought that the risk of people not seeing 275p as a no brainer was sufficiently high to need to insure it. Perhaps this should be seen as a post-Rock precaution, but it is nonetheless something to think about.