Ignoring Mervyn King's warning that the "nice" decade is behind us, the City story of the week was again banking rights issues – or rather, Barclays' decision, either brave or stupid, not to have one. Meanwhile, Bradford & Bingley, having declared a month ago that it had no intention of tapping its shareholders for more capital, then turned around and launched a cash call anyway.
Is Barclays right to resist the siren call of fee-hungry investment bankers? The argument in favour of giving in is that with everyone battening down the hatches in preparation for what may be a deep and prolonged downturn, you'd be mad not to. Forget all the bull market mumbo jumbo about the importance of an efficient balance sheet, we are now in changed circumstances. Today's priority is survival, not return on equity.
Remarkably, there even appears to be an appetite for it among investors. Banks that make themselves safer by recapitalising are rewarded with a better rating than those who choose the self-denying ordinance. What's the point in being puritanical about it when you are only punished for your non-conformity, say the investment bankers, drooling at the lips over the money for old rope to be earned from underwriting another deeply discounted rights.
There is very little that ever happens in the financial markets which is entirely new, and there is certainly nothing new about this debate. The insurance sector went through exactly the same torment back in 2002-3, when the stock market collapse caused many insurers to come perilously close to breaching solvency margins.
Some opted for rights issues, others, after a root and branch re-examination of the business model and spread of interests, for asset sales and balance sheet shrinkage. It was this latter alternative that ultimately proved the more value-creative approach. Virtually all rights issues which are not in pursuit of a specific business opportunity end up being value-destructive. Deeply discounted rights issues are in any case an exceptionally costly way of raising new capital, which always end up disadvantaging those who don't take them up.
Impairment charges associated with the credit crunch have made some banks look critically undercapitalised. In terms of its tier-one equity capital ratio, Barclays appears to be one of the worst of the lot. Yet there is no absolute rule on what the correct level should be. Banks that have too much capital tend to waste it, either on value-destructive acquisition-making or on bad lending.
As it happens, Barclays knows about this phenomenon better than any, or at least anyone who has been there for more than twenty years, which may not be that many, ought to. In the late 1980s, it launched what by the standards of the time was a whopper of a rights issue under the slogan of "Number One by Ninety One". The stated purpose was none other than becoming the biggest bank in Britain. Barclays set about its task with suitably reckless enthusiasm, using the money burning a hole in its pocket to expand indiscriminately into small business and property lending. In the subsequent downturn, Barclays lost its shirt. It's too long ago to recall whether there was another rights issue, this time a rescue rights, but there might well have been.
The present wave of banking rights issues relies on the questionable premise that banking and banks will return to the way they were as soon as the discomfort of the credit crunch is over and the economy hits calmer waters. This seems rather unlikely, both because markets themselves have become highly suspicious of the old models, and because of the near certainty of much harsher regulation. The upshot may be enforced separation of banking into its constituent parts, rather in the manner that used to be required in the US under the Glass-Steagall Act before it was finally repealed in the deregulatory frenzy of the late 1990s.
Does it really make sense for Royal Bank of Scotland to launch a distress rights issue, or might not shareholders have been better off with a more root-and-branch break-up of the bank, with asset disposals spreading beyond the planned sale of the insurance arm to the expensively acquired US businesses and other interests that have very little to do with the core, UK retail bank? This may sound like heresy, but is it any worse than tapping shareholders for billions so that the madness can begin all over again?
As it happens, Barclays probably will raise more capital some time soon, but through the mechanism of strategic investors rather than a rights issue. Is this really any better, or should not banks be reining in their global ambitions, and instead focusing on serving their customers and generating value for shareholders? Let the debate begin.Reuse content