HBOS tests City's taste for a £4bn share issue

Shares in the owner of Halifax and Bank of Scotland today rose 5½p to 502½p in hectic trading.

Dresdner Kleinwort and Morgan Stanley, the investment banks standing by to launch HBOS's £4 billion rights issue tomorrow, are judging the appetite from institutional investors for taking up their allocations or even sub-underwriting the share issue.

If they judge the mood to be right, full terms of the rights issue will be revealed tomorrow morning ahead of the bank's annual meeting.

City backing for the share issue is more crucial than in most cases because there can be no certainty that HBOS' army of small shareholders - who own almost 20% of the company - will choose to buy new shares when they feel the economy is heading toward recession.

HBOS will become the second High Street bank to call on investors for fresh capital within a week. Royal Bank of Scotland (RBS) is in the throes of raising £12 billion from its shareholders through a discounted rights issue.

At least three other banks are reported to be considering raising new capital to repair their balance sheets after damage caused by the credit crunch.

The size of HBOS's rights issue has been partly dictated by the scale of the £3 billion of writedowns it is expected to reveal tomorrow. That is vastly more than the £227 million of subprime losses the bank announced for the whole of 2007.

Analysts point out that HBOS's £7 billion of so called Alt-A loans - rated as just above subprime - is likely to have fallen sharply in value in the last month. RBS is valuing such loans at just 50% of face value.

The HBOS board will meet ahead of tomorrow's annual shareholders meeting in Glasgow to give the final go-ahead to the fund-raising.

If they approve the rights issue, chief executive Andy Hornby is expected to say that the bank is raising new funds from a position of strength. He has already signalled his belief that the British economy is slowing down, with house prices likely to fall by a single-digit percentage this year.

Hornby will argue that the bank should raise fresh capital to give it a competitive advantage over its rivals in the mortgage market.

Analysts point out that Abbey is already stealing market share using the strength of parent bank Santander's balance sheet.

HBOS has almost 2.1 million small shareholders. Some 800,000 own 200 or fewer shares while another 1.15 million have between 201 shares and 1000.

The vast majority would receive a demand to stump up a few hundred pounds to maintain their shareholding in HBOS. Those who do not subscribe for their rights could see a drop in their dividend income from their holding.