Halo slips from Sir Fred

After bullishly defending Royal Bank's capital position a few months ago, Goodwin faces an embarrassing U-turn and a fight to save his job, write Nathalie Thomas and William Lyons.

THERE was a note of arrogance in Sir Fred Goodwin's voice when, in February, he casually cast aside analysts' calculations that the Royal Bank of Scotland would have to launch a £12.5bn rights issue.

As if he was speaking to a gathering of unruly schoolchildren, Goodwin accused some of the City's most respected scribblers of "inventing" figures that suggested the bank would have to go cap in hand to shareholders to raise extra cash that would bolster its flagging capital reserves.

"The capital ratios are there. If you want to go and make up your own, feel free... It becomes a bit difficult to have a reasonable and rational conversation when people invent their own ratios," he said defiantly, doing nothing to dampen his reputation in the City as a "megalomaniac".

What a difference a couple of months can make. Last week, the bank was forced to issue a short, terse statement as rumours emerged that it will launch a share issue of between £9bn and £12bn this week.

After a string of large, high profile acquisitions – including most recently the ?71bn (£56bn) joint takeover of Dutch bank ABN Amro – sources say RBS's capital reserves are stretched to the limit. The situation has been made worse by the ongoing deterioration of the credit markets.

In an uncharacteristically defeatist statement, RBS said it had noted speculation about a "possible rights issue" but would not update the markets on its capital and trading position until Wednesday when it is due to hold its annual meeting in Edinburgh.

This morning Goodwin will relish the short respite he will receive over his Sunday morning breakfast, when he can take a few moments for himself away from the endlessly ringing telephone, and plan his next move.

The City is preparing for a scuffle at the AGM when shareholders will turn out in force to hear what Goodwin has to say for himself, particularly after he so bullishly defended the bank's capital position earlier in the year.

As shareholders reached their desks early on Friday, hoping for a quiet day ahead of the weekend, the news of the likely rights issue was greeted with cries of "U-turn" and calls for Goodwin's head.

As the implications of the rights issue developed during the day, the calls for a sacrificial lamb grew louder, with some saying that Sir Tom McKillop, the chairman, would have to go. As one source said: "It's either Fred or Tom. Unfortunately, Tom is too weak to handle Fred and I fear it could be the chairman who takes the rap."

Other analysts began asking what had happened to the strategy at Britain's second-biggest bank. RBS was generally seen to be on a steady growth path, but was now suffering from the wobbles. Goodwin, a safe pair of hands, was suddenly losing his grip.

Questions have also been asked about the performance of other directors, not least that of senior independent director Bob Scott, another whose name has been mentioned as a possible victim in any blood-letting. As the day wore on, the demand for change gathered pace. "We want someone to come in who will drive organic growth," said Paul Mumford, fund manager at Cavendish Asset Management, which owns just under 1% of RBS.

Colin Morton of Rensburg Fund Management, another shareholder, said: "It does feel like he's (Fred] walking a tightrope. If something unforeseen did happen, there is no safety net."

Many of the bigger shareholders including Legal & General, Standard Life Investments and Scottish Widows Investment Partnership were last night reserving their comments for Wednesday, when they will have the chance to interrogate Goodwin for themselves.

But one Edinburgh-based analyst said many in the City are looking for him to fall on his own sword. He said: "The rumours confirm what a lot of analysts have suspected for a while, although this has been consistently denied by the chairman and chief executive of RBS for the past six months.

"People are pretty fed up with Goodwin. I don't think his reputation in the City was ever that great. Post-NatWest, which was a success, people have seen the share price damaged with the ABN deal and his particularly aggressive and challenging manner doesn't come over well. Other than his board, I don't think he has a big fan club. I would have thought he will go now. There is a general pattern of chief executives going in the US and that trend will now spread across Europe."

Analysts and shareholders are taking an accusatory tone over ABN Amro in particular. Goodwin ignited fears at the end of last year when he pushed ahead with the takeover, in partnership with Fortis of Belgium and Santander of Spain, even though conditions in the markets had deteriorated dramatically. There were suggestions that RBS ended up overpaying for the Dutch banking giant.

But if Goodwin does decide to start writing his resignation letter this weekend, he won't be alone. Earlier this month, Martin Ospel, chairman of Swiss investment bank UBS, stepped down after delivering the double whammy of a second credit crunch-related rights issue and further write-downs of $19bn.

According to Sandy Chen, banking analyst at Panmure Gordon, Goodwin may find himself in a very similar position to Ospel on Wednesday, having to deliver the double blow of a rights issue plus further write-downs of about £5bn.

Chen argues that further write-downs at RBS are likely to be on the cards, considering its £32.7bn of net exposures to "non-market observable assets" such as syndicated loans – loans used to fund large buy-out deals which banks have struggled to sell on in the credit crisis – and collateralised debt obligations.

RBS has already written down £1.9bn since the start of the credit crunch last August. Chen suggests the bank is also likely to face higher impairment charges. "We think RBS is vulnerable (along with many of its peers) to falling house prices and rising arrears. This, we think, will lead to both further write-downs and higher impairment charges.

He adds: "Is this (the rights issue] good news? Not in our view."

Tania Gold, analyst at Dresdner Kleinwort, agrees that further write-downs "cannot be ruled out" on Wednesday. But, she suggests, Goodwin is also likely to be feeling the fiery breath of the Financial Services Authority (FSA) on his neck over the bank's capital reserves position.

According to analysts, RBS's 'core Tier 1 ratio' – a key measure of a bank's financial strength – is well below the UK average. City sources say the regulator has been leaning on RBS and other leading banks such as Barclays to improve their ratio by bolstering cash reserves.

At the end of last year, RBS had a core Tier 1 ratio of 4.5% against a UK average of 5.8%. Barclays' ratio stood at 5.1% at the end of 2007.

Gold said: "The question is why RBS is completing a rights issue. The most likely reasons are that the regulator has started to take a tougher line and is demanding more capital, or structured credit write-downs are higher than expected."

But Gold adds that the rights issue will not help RBS. She says: "The shares might outperform in the short term following any rights issue announcement... but we still believe RBS upped its exposure to wholesale (banking] at exactly the wrong time."

That said, not everyone thinks all is lost for Goodwin. While it will be difficult for him to avoid losing face over the U-turn, according to Mamoun Tazi, analyst at Man Securities, he is better off biting the bullet now before the situation in the credit markets gets worse.

With JP Morgan forecasting last week that job losses in the City will now reach 40,000 this year, double previous estimates, and Morgan Stanley warning on Friday that house prices will fall by 15% over the next two years, Goodwin's move is likely to turn out to be a wise one in the long term.

He say: "The rights issue makes a lot of sense. Once it is done, people will reconsider their position on the bank and the sector."

Tazi added that Goodwin is likely to be vindicated by the fact most UK banks will have to follow suit over the next few weeks. "The question now is: are there any UK banks who are not going to do the same thing over the next few weeks?"

Bruce Packard, analyst at Pali International, suggests one man in particular could save Goodwin's neck: his rival at Barclays, John Varley.

Rumours were circulating around some trading desks in the City on Friday morning that Varley is preparing to rush out a £10bn rights issue that could pip Goodwin to the post. A spokesman for the bank said its capital policy remained unchanged, but according to Packard, its Tier 1 ratio is also under pressure.

He said: "If you look at the equity Tier 1 ratio, Barclays is the next most stressed. They have come out and said there is no change to their capital policy. But whether the regulator says there ought to be a change to their capital policy is a different matter."

Either way, Alex Potter of Collins Stewart stockbrokers, insists any potential rights issues are not a cause for concern. "We believe RBS will have little trouble raising capital and that £10bn or so would materially remove the capital risk bear story at RBS. Therefore, whilst the rights issue will be dilutive, it is likely to mark the floor for the stock," he says.

But with the City pretty divided, only time will tell whether the name Fred Goodwin will go down in the RBS history books as a destroyer or saviour of the bank.