HBOS was a sitting duck
From the moment HBOS unveiled its $8 billion rights issue the hedge funds could smell blood. But it's the extent of the overhang that will make this one of the most disastrous share underwritings in history.
Overnight, the extent of what may go down as one of the most disastrous share underwritings in history will be exposed when Morgan Stanley and Dresdner Kleinwort reveal the size of the shortfall to the $8 billion HBOS rights issue.
In the process, the investment banks will help fuel the paranoia about the impact of short selling in the current environment, and harden the resolve of the UK and US regulators to introduce measures to deter the full-scale assaults hedge funds have been making on vulnerable financial stocks.
The HBOS experience has informed the UK authorities' decision to force hedge funds to disclose their short positions in companies conducting rights issues. The Financial Services Authority has also indicated it may limit the ability of short sellers to borrow stock in such circumstances. Last week the US Securities and Exchange Commission rushed out a policy under which it banned 'naked' short selling in 19 specified financial stocks.
When Morgan Stanley and Dresdner Kleinwort reveal all tomorrow it is widely expected that they will disclose a shortfall to the issue of close to 90 per cent – about £3.5 billion, or more than $A7 billion.
That's despite the fact that the issue was originally made at a 45 per cent discount to the HBOS share price and, at 275p, represents a multiple of less than three times earnings and a discount of almost 50 per cent to book value.
When the issue was announced in late April HBOS shares were trading around £5. Until last Friday, when the shares traded just above the issue price of 275p, the bank's shares had been trading at just over half that. While the volatile and fragile condition of credit markets and real economies might be a contributing factor to the implosion in the HBOS price, most of the 'credit' is going to the short sellers.
From the moment HBOS unveiled the issue the hedge funds smelled blood. HBOS was an easy target in an environment when any bank seeking to raise capital is seen to be under pressure and vulnerable.
The gameplan was straightforward, cold-blooded and extremely effective. The hedge funds piled into the stock, shorting it aggressively. The more timid would have been buying the rights (the value of which was also being driven down by the selling) as cheap insurance in case the bear raid wasn't as effective as hoped while the more aggressive would be waiting for the underwriters to be forced to disgorge the expected shortfall.
It was game with little risk. Indeed at least one of the big European investment banks was inciting the hedge funds to join the assault, arguing that if there was sufficient selling pressure the underwriters would be forced to protect themselves against the prospect of a major shortfall by selling their client's stock short themselves.
As it happens, it would appear Morgan Stanley and Dresdner Kleinwort didn't attack their own client – they appear to have sold other bank stocks short instead to create a hedge against loss. Royal Bank of Scotland shares were down nearly 20 per cent at one stage last week.
The investment banks have passed some of the risk/losses onto sub-underwriters, although most in London appear to believe that only about 40 per cent of the issue was underwritten. If weekend reports are correct the underwriting panel now owns about £3.5 billion of HBOS stock, with Morgan Stanley and Dresdner Kleinwort left with more than £2 billion in shares.
No investment bank wants to be a long-term holder of that kind exposure, which means that the shares will find their way into the market sooner rather than later. Apart from any losses their forced sale might create for the banks the over-hang should depress the HBOS share price for some time to come.
The HBOS experience underscores the near-helplessness of financial institutions to respond to an attack by the short sellers. In the UK the vulnerability has been exacerbated by the length of a right issue timetable, which is very protracted because of the need to obtain shareholder approval. In this case for example, the issue was announced back in April.
In this environment and with equity markets priced where they are no bank will want to raise equity – unless they have to. The instant sources of equity – sovereign wealth funds, private equity and Arab oil sheiks – have been scared off by their initial and very costly forays into the post sub-prime environment. The only source of large-scale capital for a bank under pressure at the moment is its own shareholders.
After the HBOS experience, no sensible underwriter will go anywhere near a bank issue, regardless of the size of the discount to the pre-issue market or the underwriting fees. Without an underwriter to guarantee the capital will actually be raised, a hedge fund attack on a bank equity issue could bring a bank down. Not that that would concern the funds.
In this market, Westpac tried to go it alone with a non-underwritten rights issue in 1992 and was facing a catastrophe until Credit Suisse baled it out at the 11 hour. The issue closed with a shortfall of about 75 per cent. (The shortfall almost handed effective control of the bank to Kerry Packer ).
Whether or not the UK and US regulators have made the right responses to the dangers of allowing short selling of key financial stocks, they have come to the right conclusion. Whatever the merits of short-selling in normally functioning markets (and there are some) in the current circumstances it adds instability and combustibility to core components of the financial system.
Like Fannie Mae and Freddie Mac in the US, HBOS is too big and important for the UK regulators to allow it to fail. It makes sense for legislators and regulators to discourage behaviour that might increase the likelihood that the taxpayer will be called on for support.
In the process, the investment banks will help fuel the paranoia about the impact of short selling in the current environment, and harden the resolve of the UK and US regulators to introduce measures to deter the full-scale assaults hedge funds have been making on vulnerable financial stocks.
The HBOS experience has informed the UK authorities' decision to force hedge funds to disclose their short positions in companies conducting rights issues. The Financial Services Authority has also indicated it may limit the ability of short sellers to borrow stock in such circumstances. Last week the US Securities and Exchange Commission rushed out a policy under which it banned 'naked' short selling in 19 specified financial stocks.
When Morgan Stanley and Dresdner Kleinwort reveal all tomorrow it is widely expected that they will disclose a shortfall to the issue of close to 90 per cent – about £3.5 billion, or more than $A7 billion.
That's despite the fact that the issue was originally made at a 45 per cent discount to the HBOS share price and, at 275p, represents a multiple of less than three times earnings and a discount of almost 50 per cent to book value.
When the issue was announced in late April HBOS shares were trading around £5. Until last Friday, when the shares traded just above the issue price of 275p, the bank's shares had been trading at just over half that. While the volatile and fragile condition of credit markets and real economies might be a contributing factor to the implosion in the HBOS price, most of the 'credit' is going to the short sellers.
From the moment HBOS unveiled the issue the hedge funds smelled blood. HBOS was an easy target in an environment when any bank seeking to raise capital is seen to be under pressure and vulnerable.
The gameplan was straightforward, cold-blooded and extremely effective. The hedge funds piled into the stock, shorting it aggressively. The more timid would have been buying the rights (the value of which was also being driven down by the selling) as cheap insurance in case the bear raid wasn't as effective as hoped while the more aggressive would be waiting for the underwriters to be forced to disgorge the expected shortfall.
It was game with little risk. Indeed at least one of the big European investment banks was inciting the hedge funds to join the assault, arguing that if there was sufficient selling pressure the underwriters would be forced to protect themselves against the prospect of a major shortfall by selling their client's stock short themselves.
As it happens, it would appear Morgan Stanley and Dresdner Kleinwort didn't attack their own client – they appear to have sold other bank stocks short instead to create a hedge against loss. Royal Bank of Scotland shares were down nearly 20 per cent at one stage last week.
The investment banks have passed some of the risk/losses onto sub-underwriters, although most in London appear to believe that only about 40 per cent of the issue was underwritten. If weekend reports are correct the underwriting panel now owns about £3.5 billion of HBOS stock, with Morgan Stanley and Dresdner Kleinwort left with more than £2 billion in shares.
No investment bank wants to be a long-term holder of that kind exposure, which means that the shares will find their way into the market sooner rather than later. Apart from any losses their forced sale might create for the banks the over-hang should depress the HBOS share price for some time to come.
The HBOS experience underscores the near-helplessness of financial institutions to respond to an attack by the short sellers. In the UK the vulnerability has been exacerbated by the length of a right issue timetable, which is very protracted because of the need to obtain shareholder approval. In this case for example, the issue was announced back in April.
In this environment and with equity markets priced where they are no bank will want to raise equity – unless they have to. The instant sources of equity – sovereign wealth funds, private equity and Arab oil sheiks – have been scared off by their initial and very costly forays into the post sub-prime environment. The only source of large-scale capital for a bank under pressure at the moment is its own shareholders.
After the HBOS experience, no sensible underwriter will go anywhere near a bank issue, regardless of the size of the discount to the pre-issue market or the underwriting fees. Without an underwriter to guarantee the capital will actually be raised, a hedge fund attack on a bank equity issue could bring a bank down. Not that that would concern the funds.
In this market, Westpac tried to go it alone with a non-underwritten rights issue in 1992 and was facing a catastrophe until Credit Suisse baled it out at the 11 hour. The issue closed with a shortfall of about 75 per cent. (The shortfall almost handed effective control of the bank to Kerry Packer ).
Whether or not the UK and US regulators have made the right responses to the dangers of allowing short selling of key financial stocks, they have come to the right conclusion. Whatever the merits of short-selling in normally functioning markets (and there are some) in the current circumstances it adds instability and combustibility to core components of the financial system.
Like Fannie Mae and Freddie Mac in the US, HBOS is too big and important for the UK regulators to allow it to fail. It makes sense for legislators and regulators to discourage behaviour that might increase the likelihood that the taxpayer will be called on for support.
Share this article and show your support
Call 1300 880 160
Start a chat
Schedule a call
