Government bank bailout

Well, with hindsight I did get a good price on Monday (about 160p I think) but I spurned it. Shame - RBS are now at 70p. Which I think is crazily low, especially given the government bailout plans. I suppose there's a chance RBS will have to suck up some big losses on Lehman CDSs - I would be seriously unimpressed if they have much exposure though. The other big worry is that shareholders will be massively diluted.

Analysts have been saying that RBS will raise about £10bn. I think they're probably not far wrong. The government said that banks would raise about £25bn between them. To take them up to a 10% tier 1 ratio, I reckon they need:
Barclays about £5bn
RBS about £10bn
HBoS about £5bn
Lloyds about £3bn
HSBC about £1bn
That adds up to £24bn.

RBS's market cap is currently about £11bn. Some newspapers are suggesting that they will try to raise £10bn via a rights issue underwritten by the government. Surely not? That would be hugely dilutive at the current share price.

I think they would be far better off giving the government preference shares. Alastair Darling strongly pushed the benefits of preference shares in his Commons speech, so it seems that's what the government has in mind.

If RBS give the govt £10bn of perpetual, non-cumulative, non-convertible preference shares paying a dividend of 10%, what would that mean? Maybe we can assume some sort of normality in a few years - let's say £7bn of profit after tax. The govt would take £1bn of that. With a total dividend payout of 45% that would leave 13.4p per share for ordinary shareholders. And crucially, the remaining 55% will be reinvested to benefit ordinary shareholders - preference shareholders will just continue to get their 10% per year. So that's £3.85bn reinvested - even with a lower return on equity (say 10%) that means 5.5% growth of total profits, but 6.4% growth in profit attributable to ordinary shareholders. A yield of 5%, growing at 6.4% a year would be perfectly acceptable. That would suggest shares will be worth about 270p. A P/E ratio of 7, which you could also imagine rising to around 10 in a future bull market.

On the other hand, things do not look so rosy if governments receive convertible shares, or ordinary equity. The lower RBS's share price goes, the worse this option looks. Preference shares convertible at 62p, or a rights issue at the same price, would mean 50% dilution. Using the same profit calculations you end up with earnings per share of about 22p and a 10p dividend. So a share value of perhaps 200p.

It will be interesting to see how this turns out. I'll hold onto my shares, since I since there's little point bailing out at this low price, but my highest hopes at the moment are to break even in a few years.