HBOS, the financial group that owns Halifax and Bank of Scotland, has today announced it is planning to raise £4 billion through a rights issue.

This means each one of HBOS’s two million shareholders will be invited to subscribe for fresh shares in the mortgage bank which, like other financial groups, has been hard hit by the global credit crunch.

Times Money offers the following question and answer guide for small shareholders who are unfamiliar with rights issues and do not know what their options are.

Q: What is a rights issue?

A: A way for companies to raise fresh capital from their existing shareholders. Because the additional shares issued effectively dilute the value of investors’ earnings from the company they are offered at a discount to the prevailing share price.

Q: Why is HBOS taking this step?

A: HBOS says it is aiming to strengthen its balance sheet. Another way of putting it would be that the rights issue provides HBOS with more money at a time when liquidity has dried up because the credit crunch has made financial groups wary of lending to each other.

Q: What are the terms of the rights issue?

A: For every five HBOS shares held, investors will be offered the chance to purchase two new HBOS shares. The shares are being offered at 275p - a 45 per cent discount on today’s opening price of 495p.

So if you currently hold 500 shares, you will be offered the right to subscribe for 200 new shares at 275p. If you take up the offer you will have to stump up £550.

Q: What are my options?

A: You can accept the offer, pay the sum required and receive your additional shares. Alternatively you can decline the offer and sell your rights, or let them lapse, in which case you will receive the prevaiing market price for them, minus dealing costs.

A third option is to take up some of your rights and sell the remainder.

Q: It sounds like a no-brainer. I pay 275p for shares that are trading at 495p. Isn’t that an easy way to make money?

A: Not necessarily. When the new shares are issued the price of the existing shares moves down to adjust for the rights issue. In fact the process usually starts as soon as the rights issue announcement has been made.

Q: What happens now?

A: HBOS will send out a chunky prospectus explaining the terms and conditions of the rights issue in great detail. This is scheduled to happen in late June, following which there will be an Extraordinary General Meeting, at which shareholders will be asked to vote on the rights issue propsal.

If the vote is carried the rights issue will be completed in late July.

Q: What are the prospects for HBOS shares?

A: The best one can say is mixed. Nic Clarke, of Charles Stanley, the stockbroker, says: “The bank’s capital position is not as stretched as some other UK banks, so it will be in a relatively strong position compared to them, but its fortunes are closely tied to the UK house market, which is entering a bad patch.”

Richard Hunter, of the stockbroking arm of Hargreaves Lansdown, says: “HBOS looks to have got most of the bad news out of the way with its latest writedowns of £2.8 billion, but the dividend cut is not pleasant and the UK mortgage market is not looking healthy right now. What it boils down to is this: if your rights issue take-up would cost £1,000, do you think is this the best way to invest £1,000?”

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