ALL BUSINESS: Investors on losing end when capital raised

By RACHEL BECK AP Business Writer

NEW YORK (AP) - Financial company shareholders must feel like second-class citizens now, given how they are being treated as some banks raise capital.

It's bad enough that investors in National City Corp. and Washington Mutual Inc. have seen their stock holdings plunge in value and dividends crimped because of the huge losses caused by the housing slump and credit crisis.

Now comes the next hit: Their ownership stakes are shrinking as companies use heavily discounted shares to woo new investors who often see immediate paper profits at existing shareholders' expense.

Don't get me wrong: financial firms are struggling and they need the money. Capital represents the assets left after subtracting liabilities. As the credit crisis has spread, it has become a crucial measurement of a firm's ability to weather potential losses.

Faced with a capital crunch, National City's executives said on April 21 that an investor group led by buyout firm Corsair Capital was putting $7 billion into the Cleveland, Ohio-based bank and mortgage lender.

Back when the housing market was strong, "National City overloaded on high risk real estate and deployed a lot of capital to buybacks and acquisitions," noted Goldman Sachs analyst Brian Foran. But now it has been stung by the surge in delinquencies in subprime and residential construction loans.

The company lost $171 million in the first quarter, and just slashed its 21-cent dividend down to just a penny a share.

National City agreed to let the Corsair-led investor group buy 126.2 million shares of common stock for $5 each - a 40 percent discount to where shares were trading before the deal was announced. The lender will also raise $6.4 billion by selling preferred stock to the investor group that converts at the same price. Those investors will receive warrants with an exercise price of 115 percent of the company's average closing price for the five-trading-day period beginning April 21, with a cap of $8.50 per share.

By allowing all those new shares to come into the marketplace, the deal is about 70 percent dilutive to existing shareholders' ownership position, according to Goldman Sachs. That comes on top of the 80 percent plunge in the stock over the last year. On the flip side, the new investor group got a sweet deal, having already racked up paper profits topping $1 billion.

During a conference call with analysts discussing capital infusion, one question to management focused on why there wasn't a "a more palatable alternative." National City CEO Peter Raskind responded by saying there was a need to raise enough capital "to stabilize our debt ratings, beyond a shadow of a doubt," and he noted, that it had "counter-parties who were uncomfortable interacting with us. That had to stop."

A similar scenario also played out earlier in April when Washington Mutual said it would raise $7 billion from an investor group led by private-equity firm TPG. The Seattle-based thrift privately placed $1.5 billion in stock, sold at a 33 percent discount to where the stock had been trading before the announcement. Investors will also receive $5.5 billion in convertible preferred shares, also at a discount.

But does raising capital have to sell current shareholders so short? Absolutely not - and it's up to existing shareholders to make it clear to nation's financial companies that they won't stand for it.

A preferred route might be like the one taken by Royal Bank of Scotland, which announced on April 22 it would do a "rights issue" to shore up its capital by nearly $24 billion. That's when a publicly traded company offers existing shareholders the opportunity to buy company shares at a discounted price within a certain time frame.

RBS, which has seen its capital depleted by the global credit squeeze, and by the acquisition it led last year of Dutch bank ABN Amro, will seek approval for the rights offering during its annual meeting next month. It wants to offer current investors 11 new shares for every 18 existing shares at $3.98 each - a 46 percent discount to where the stock was trading before the deal was announced.

That deal would allow the company to raise capital without selling a major stake to new investors. But it also puts existing shareholders in the position of facing bigger losses should the business not improve in the months ahead.

Still, there are some incentives for shareholders to participate - if they get new shares for less than the current stock price, they have a better opportunity to realize gains and that might help offset losses they've already had.

Given what investors have been through, there is something to be said about having a chance at some winnings.

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Rachel Beck is the national business columnist for The Associated Press. Write to her at rbeck(at)ap.org