Short Selling Ban May Raise Cost of Selling Convertible Bonds

As those who are following the banking industry know full well, bank stock prices are so depressed that selling new shares is at best unattractive, at worst massively dilutive.

One of the big reasons for the campaign against evil shorts was that one a financial firm’s price falls below a certain level, it is in dire shape. it cannot raise needed new equity, and if it looks overlevered, the prohibitive cost of selling stock could lead to a downgrade, since rating agencies won’t see any way for the company to strengthen its balance.

But what regulators give, they also take away. The Financial Times tells us that the short selling ban may hurting the market for convertible debt, another favored way for banks to raise capital.

From the Financial Times:

Convertible bond arbitrageurs had the worst performance of any hedge funds, according to investors, as large portfolios of bonds were dumped into the market – probably, said several managers, as Lehman Brothers’ proprietary trading desks closed.

The heavy losses for convertible arbitrage, coupled with the removal of the funds’ ability to lower the risk of holding bonds by short selling the linked equity, could make it much more expensive for companies trying to raise capital through convertibles, managers said. Convertible bond arbitrage involves hedging out the equity or credit risk, or both, often trying to profit by trading the value of the embedded option to convert the bond into shares.

So far this year, banks and other financial companies in the US have raised more than $35bn, one fund calculated, as the convertible bond market – which is dominated by hedge funds – remained one of the few still open at a reasonable price.

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  1. Steve

    Perhaps Messrs. Paulson and Bernanke will embrace `level 3 equity’ — just book $5 for every $1 of new common issued. They embrace fictitious asset valuations, so why not equity? All problems will disappear like magic.

    As Paulson’s tennis instructor and accounting guru Aleksey Vayner famously observed, `Impossible Is Nothing.’

  2. Richard Kline

    I want a bank holiday, and I want it now. Seriously, the issue we face with the financial system is not a choice between an orderly or a disorderly deleveraging. Rather, it is a question of separating the insolvent from the solvent and solveable, so that the insolvent quit soaking up credit and equity which they will only squander. Those calling for the Paulson proposal advocate an inoculation via taxpayer transfusion, when what we need is a cull. Goats and sheep; drowned and saved; zombies and cuddlies: All is delusion and waste until we face that fact.

    Takedown not Bailout.

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