Banks in distress: should shareholders answer the cash call?

Investors invited to raise their stake should think before they buy. By Laura Harding and Julian Knight

Thanks to the credit crunch, many of the UK's biggest banks have run short of ready cash. They need to shore up their finances and one way to do this is via a rights issue.

This is when a company, in a bid to raise funds, creates more shares and sells them to existing shareholders at a discount. Last week Halifax Bank of Scotland (HBOS) set out its plans to raise £4bn in this way. The bank gave its shareholders the right to buy two new shares for every five existing ordinary shares at 275p each, reduced from 345p.

The discount price gives investors an incentive to buy. If they decline the offer, they can find their current holding is diluted as more shares come on to the open market.

HBOS has more than two million shareholders across the UK and the average holding is 374 shares. Under the proposed rights issue, the average individual shareholder will be allowed to buy 149 new shares at 275p per share – a total cost of £409.75. If the rights are not taken up, the company may sell them on the stock market.

Dennis Stevenson, the chairman of HBOS, told shareholders that its rights issue would "strengthen the group's capital base".

It's not just HBOS that is asking shareholders for extra cash. In April, Royal Bank of Scotland (RBS) announced a £12bn rights issue. The issue, which closed on Friday, means 11 new shares will be issued for every existing 18 shares at 200p each, about 30 per cent below the UK market price. And last Tuesday, as part of a disastrous trading statement, the UK's eighth-biggest bank, Bradford & Bingley, was forced into the humiliating step of reducing the price it had announced for its rights issue. The bank's 850,000 shareholders will now be offered the shares at 55p each rather than the originally proposed 82p.

In total, just over three million shareholders are affected by the rights issues being carried out by RBS, HBOS and Bradford & Bingley, and if you are one of them then you are entitled to buy the new shares.

But it could be the wrong move to snap them up just because they are cheap. Ian Hudson of independent financial adviser Hudson Green and Associates warns: "First of all ... do you really want to buy further into a company that needs more money to stay liquid? You should be a bit cynical about that. You should also think about the financial commitment ... especially if you haven't got a lot of money to spare."

Graham Ashby, UK head of retail equities at the banking giant Credit Suisse, says mounting personal financial pressures could also deter shareholders: "The timing of these rights issues from the banking sector for many investors couldn't be much worse.

"With disposable incomes under pressure due to rising energy costs, food inflation and mortgage payments, some investors may be reluctant to throw good money after bad – particularly as the dividends for these will be significantly reduced from last year's levels."