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.”