Should you be taking up your entitlements to extra bank shares?  We will use RBS as an example here but the same logic applies to LLOY and HBOS.  An important advantage a private investor has over institutions is that they can take a multi-year view as opposed to worrying about how their performance will look at the next quarter-end.  This analysis is very broad-brush and simplifies much, but then who said investing had to be overly complex.  To rehash a Warren Buffet quote – “If it takes more than elementary maths to understand then don’t bother investing”.  The UK Government decided recently that in order to boost confidence in all UK banks, they should have much higher Core Tier 1 capital ratios than the prevailing 6%-ish levels and that in order for the banks to raise the necessary capital in a hurry the Government would provide the extra capital, if necessary. 

There were approximately 16.5 bln RBS shares outstanding before the UK Government agreed to underwrite a £20 bln capital raising.

£15 bln will be raised by issuing roughly 22.9 bln new shares at 65.50 pence.  The other £5 bln comes from preference shares issued to the UK Government.  Assume that in the next few years, once RBS has made its write-offs and the dust has settled, it gets back to making the £10 bln p.a. that it made in 2006/7 (higher net interest margins will help this profits rebound).  Assume further that it makes a 10% pre-tax return on the £20 bln of new capital it has just raised.  Tax those £12 bln of earnings at 28% and subtract preference dividends of £600 mln (12% on £5bln).  You end up with EPS of 20 pence on 39.4 bln shares.  Bank shares on prospective P/E ratios of approximately 3x are worth tucking in the bottom drawer…take up your entitlements (or buy the shares in the market if they are trading below the subscription price).