Normally, underwriting a public stock offering is a highly profitable, low risk business. In the US, managers and underwriters collect a handsome fee (7% gross spread on IPO, lower on secondary offerings) but assume virtually no risk, because the deals are (usually) pre-sold via investor commitments (circles) before the deal is priced and the underwriters buy it (technically, they purchase it and then re-sell it to the final owners).
But there is usual, and then there are the exceptions, and the downside of a hung IPO is huge. The underwrites are stuck with a massive block of stock, and the whole world knows they need to unload it. Not a pretty place to be in.
But that;s precisely the position that Morgan Stanley, Dresdner Kleinwort, and the members of the underwriting syndicate may soon find themselves with an ill-fated HBOS underwriting. From the Telegraph:
Morgan Stanley and Dresdner Kleinwort are facing a £4bn bill for underwriting HBOS’s rights issue after shares in the Halifax owner collapsed below the price of the planned cash call yesterday.
HBOS shares closed at 258p, down 34 yesterday and 17p below the rights price, amid a sector rout that saw £8bn wiped from the value of banking shares. The sell-off led to rumours that a large hedge fund with long positions in UK housebuilders had gone bust and been forced to liquidate its positions.
Royal Bank of Scotland tumbled 21 to 212¼p after 60m shares were placed in a single trade, a volume large enough to raise eyebrows in the City. The fall came despite a neutral trading statement that chief executive Sir Fred Goodwin described as containing “no new news”.
HBOS has been under pressure from short-sellers since announcing its rights issue on April 29. In the seven weeks, its shares have fallen from 495¾p. The final collapse yesterday came even though the bank stated that there had been no material change to performance, saying: “Current trading, and specifically mortgage arrears performance, is in line with the group’s expectations.”
Bankers said that HBOS’s decision to confirm in the same statement that the “fully underwritten rights issue is proceeding according to plan” indicated that Morgan Stanley and Dresdner remained on the hook for the £4bn. UBS and Citigroup, by contrast, were released from their obligations in Bradford & Bingley’s aborted £300m rights issue last week after the buy-to-let lender issued a profits warning.
At the close, Morgan Stanley and Dresdner were suffering a £250m paper loss. Their underwriting fees, to be revealed in the prospectus next week, are believed to be between £80m and £100m.
Should they be forced to prop up the issue, it would be the first time underwriters have incurred a loss since Goldman Sachs at BP’s flotation in 1987, when the stock market crashed. It could also leave them with effective control of the bank, financiers noted, as the banks would then own roughly 30pc of the enlarged HBOS equity.
There are still five weeks of trading in HBOS shares before the rights issue closes, by which time both underwriters expect the stock to recover. They have already placed much with sub-underwriters. Neither would comment.
The Financial Services Authority (FSA) is also said to be confident that the fund-raising will proceed, though it declined to comment.
HBOS is Britain’s biggest savings bank, with £158bn of retail customer deposits, and the largest mortgage lender with 20pc of the market and £235bn on loan.
The regulator is also said to be keenly scrutinising short-sellers for any evidence of “trash and dump”, whereby shorters spread negative information before offloading the stock. Earlier this year, HBOS was the victim of false rumours that led to an 18pc run and statements from the FSA and Bank of England.
Some further detail from the Times Online:
As the 275p price level was breached, HBOS issued a statement that the rights issue would go ahead on the present terms and insisted the underwriting agreement was bullet-proof….
HBOS has been an enthusiastic buyer of housebuilders, with stakes in Crest Nicholson, McCarthy & Stone, Cala, Keepmoat, Apollo, Miller and Tulloch and has loans outstanding to some of them….
Housebuilders blamed short-selling hedge funds for another day of plunging share prices….
Fears that the current round of capital-raisings by UK banks will not be enough further hit their share prices.
Robin Geffen, the founder of Neptune Investment Management, said that banks had still owned up to only half of the $2 trillion of losses they have sustained.
“So the banks are on the first of at least two rights issues.”…
One source close to HBOS said: “HBOS would rather be in the queue for capital than sweating on the sidelines.”
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Deary me, what is this trend? HBOS, Lehmans, Bradford and Bingley? Sure they can do a sweet pref share deal with a SWF but go ahead and try to dilute the heck out of the commoners? They’ll walk with their feet.
I thought RBS were not far from the line in the sand either– wasn’t their rights price at 200p? And shares closed where? 212.5? What about the 5% of rights unsold that were placed around 230? This is not good.
The CFO of Lehmans was confident in their numbers, implying they cherry picked the portfolio, selling off the dregs and leaving them with future returns from the remainder that will defy naysayer thoughts of diminished performance. Given this and the underwater rights offering, shouldn’t Carl Icahn be salivating at the lips now? What is the market doing to this stock?!
They break it; you bought it: Does this snap-back owwie suggest that _no one in their right mind_ will underwrite further major equity issuance for top tier financials in present conditions? But, but, those Top Tierians need to raise as much capital and more _still_ as they have aleady, which means . . . .
The continuinng sale of capital in Big Financials over the last eleven months has been your basic suckers’ rally. These firms have had life-threatening losses locked into their inboxes from last July on. Everyone and anyone who has bought big paper to hold on financials is a total sucker. . . . But then those new ‘buyers’ took the junk to short it, maybe, right? Kind of like Shuttlecock the Hand Grenade, but it’s the other fella who’ll lose an arm, right? Right??
The next major financial to turn turtle and head down by the nose will be the one that sucks down the last of false illusions re: the scale of the present problem, whether in the UK, the US, of Europe proper. Hedgies don’t count for as much, leverage nothwithstanding, and mostly they have nothing like the assets which may come unmoored and swamp the liquidity pool. I have no idea whether RBS, WM, HBOS, LEH, MS, or who know will be the one—but the next one to roll does so on the first day of the rest of our lives (under new management).
http://www.bis.org/publ/bcbs_wp13.pdf
from the BIS website:
“The Japanese Financial Crisis during the 1990s
Summary
Up to March 2002, 180 deposit-taking institutions were dissolved under the deposit insurance
system in Japan. The total amount spent dealing with the problem of non-performing loans
(NPLs) from April 1992 to September 2001 was Y102 trillion (20% of GDP). This section
describes the financial crisis management in the 1990’s, dividing the period into five broad
stages.”
and
“Causes of the financial crisis in 1990’s
One of the unusual aspects of Japan’s banking crisis is the length of time it took to address
the problems. While there were various problems that jointly caused the crisis, this section
focuses on the problems of non-performing loans (NPLs) and banks’ capital positions, two
primary sources of the crisis, and explores reasons why it has taken so long to contain the
crisis.”
Reasons (redacted)
1-Problem on non-performing loans
2-Negative impact on the economy
3-Insufficient provisioning
4-Inadequate market discipline
5-Deterioration in banks’ capital positions
Look familiar? And remember how we used to look at them from afar and say, “Oh that would never happen to us! We’d slash NPLs and raise capital instantly….”
Yves, the troubled HBOS rights issue could have negative implications for Barclays. With a Tier 1 ratio just under 5% and risks that Barclays has not disclosed its conduit and CDO exposures nor marked them down wnough, a rights issue for Barclays could be at a real discount to the current share price – which has fallen more than 30% since RBS announced its offering. At this point, I think we start to zero premium mergers – two drunks standing back to back to prop each other up!
Looks like this will be the biggest failure ever of a rights issue. Maybe the value guys are all tapped out…