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RBS Planning Rights Issue Next Week

Royal Bank of Scotland is set to announce a rights issue next week, an industry source said on Friday, in a move which analysts believe could raise over $20 billion and lead to similar action by other UK banks.

A Royal Bank of Scotland logo is seen outside the company's offices in central London, Tuesday May 29, 2007. A consortium led by Royal Bank of Scotland PLC said Tuesday it will launch a hostile bid of euro71.1 billion (US$95.5 billion) for ABN Amro, topping a friendly offer from Barclays PLC and pressing Bank of America Corp. for control of the Dutch bank's U.S. arm. (AP Photo/Matt Dunham)
Matt Dunham
A Royal Bank of Scotland logo is seen outside the company's offices in central London, Tuesday May 29, 2007. A consortium led by Royal Bank of Scotland PLC said Tuesday it will launch a hostile bid of euro71.1 billion (US$95.5 billion) for ABN Amro, topping a friendly offer from Barclays PLC and pressing Bank of America Corp. for control of the Dutch bank's U.S. arm. (AP Photo/Matt Dunham)

The capital increase, long rumored in the market but frequently dismissed by RBS management, is a radical u-turn for Britain's second-largest bank and the first major capital hike for a British lender since the start of the credit crunch.

It could also, as potentially the largest capital increase to date in Britain, mark the end of an era for the bank's well-respected chief executive, Fred Goodwin.

Analysts and shareholders say he would face an uphill struggle to push through a hefty capital increase and remain in the job.

RBS said in a statement on Friday that it noted speculation about a possible rights issue, but gave no further comment.

It is due to publish an update on its trading performance and capital on Wednesday, to coincide with its shareholder meeting.

RBS has so far suffered a relatively modest $3.2 billion writedown from toxic assets, but it bears the scars of recent market turmoil and its balance sheet was stretched by its leading role in the 71 billion euro ($113.3 billion) takeover and break-up of Dutch bank ABN Amro last year.

"Broadly speaking, I think it would be a good thing. I wish they'd done it before -- and I don't think anyone is that surprised," Edward Collins, a fund manager at New Star Asset Management who owns RBS shares, said.

"But (Fred Goodwin) is going to have to explain the reasoning. He's been emphatic it wasn't going to happen and this calls into question some of the assumptions they made when they did the ABN deal, albeit under different market conditions."

The bank has some of the weakest capital ratios among European banks, with a core Tier 1 ratio of 4.5 percent at the end of 2007, well below the UK sector's 5.8 percent average, and seen as a key reason for its share-price underperformance.

RBS avoided a rights issue after its acquisition of Charter one in 2004, but the market environment this time has already pushed a string of major banks from Merrill Lynch to UBS into emergency fundraising, and will make it far tougher to rebuild ratios through earnings and asset disposals.

Shares in RBS, which have dropped 18 percent so far this year and largely discount a capital increase, initially rose strongly on reports of a capital hike and were up 4.9 percent at 384p.

"The valuations are already so low -- if they don't do a rights issue, over time they will rebuild their capital ratios. If they do, it will be dilutive to returns but at least the capital fears would be erased and they will rerate," Exane BNP Paribas analyst James Eden said.

"It puts the fear behind them."

Quid Pro Quo?

The source, who has direct knowledge of the matter, said the rights issue could coincide with a government plan to ease tension in the mortgage market due as early as next week.

The move to shore up the balance sheet, analysts said, could in fact be a condition imposed by UK authorities before they agreed to step in to boost liquidity in the market.

"It is something of u-turn for Fred Goodwin. The fact that he has changed his mind so quickly would suggest there has been meddling from elements within the tripartite authority," Exane BNP Paribas' Eden said, referring to UK financial regulators.

If the government plan, which is expected to allow banks to swap mortgage-based securities temporarily for government bonds, is behind the RBS about-turn, other banks could follow -- despite concerns of rekindling memories of unpopular emergency rights issues in the 1980s.

Analysts say Barclays, with a core Tier 1 capital ratio of 5.1 at the end of last year, and HBOS, also hit by the falling property market, were the next most thinly capitalized banks.

Both banks declined to comment on Friday.

"From a UK economy point of view, the option of doing nothing by the UK banks is clearly no longer feasible," JP Morgan said in a note.

Analysts said the key to RBS's success now lay in the mechanism, price and size of the rights issue -- with estimates rising well above 13 billion pounds -- and whether it will be accompanied by a further writedown of risky assets.

Shares in Swiss giant UBS suffered after an initial capital raising was not seen as going far enough, and jumped when it set a second issue and doubled its asset writedowns to $37 billion, on hopes it was finally getting to grips with its problems.

One route for RBS could involve following UBS with a scrip dividend and back that with asset sales, long seen as likely, although the bank has said it will not be pushed into firesales.

The bank is already considering the sale of train leasing business Angel Trains, which could fetch over 3 billion pounds.

In more radical moves, it could sell its stake in Bank of China, its insurance unit or even U.S. arm Citizens -- all of which would go against previous strategy.

Goldman Sachs and Merrill Lynch are arranging the RBS rights issue, a source familiar with the situation said.

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