Financial institutions: HBOS detractors jump the gun
Bank rights issues: A right mess of issues
Even summer sale prices with almost 50% reductions turned out to be not quite generous enough to entice investors to take up their rights in HBOS’s dismal issue. The mortgage lender’s share price fell beyond the 45% discount announced at the start of the deal’s subscription period in April as share prices across the sector tumbled on a stream of bad news.
HBOS received the £4 billion ($8 billion) in cash that it needed to raise, thanks to hard underwriting commitments, but the low take-up means that the deal did not succeed in raising confidence – in itself hardly helped by a 58% drop in profits for the first half of 2008.
The failure of the HBOS deal, and the difficulties facing other British banks seeking to raise capital, have focused attention on to the role of shorting during rights issues.
The Association of British Insurers, whose members own more than 20% of the UK stock market, is the latest to offer its two cents-worth, by calling for investment banks to restrict short selling during rights issues and make sure that sub-underwriting is only passed on to investors with a genuine long-term interest and not to those who might offset their risks through short selling.
The ABI’s comments come just weeks after the Financial Services Authority introduced new rules requiring investors to declare significant short positions in companies undertaking rights issues.
The obsession with the evils of short selling, however, is somewhat misguided, as short selling is most often a symptom rather than a cause. Unfortunately, investors have not lacked good reasons to short bank stocks recently as share prices across the sector have suffered from a series of dreadful results and an uncertain outlook. Share prices have plenty of reasons to fall with or without short selling.
Long-only investors who criticize hedge funds for short selling also open themselves up to charges of hypocrisy since they profit from allowing their stock to be lent out to the short sellers.
While the ABI calls out strongly for a clampdown on short selling during rights issues, it suggests only "possibly" that there might be a need to do the same for stock lending.
The association’s exhortation to underwriters to place stock in the hands of sub-underwriters who won’t short the stock is unnecessary, because it is in the underwriters’ interest to place stock with those who will be a supportive force for the issuer’s share price. If they do otherwise it is because they cannot find anyone better, which means that the real problem is a lack of demand for an issuer’s stock at the set price level.
The focus on limiting short selling as a way to support rights issues misses the point. Stopping short selling will not stop share prices falling if investor demand isn’t there. What would make a difference, and what the ABI more usefully suggests, is ways to shorten the subscription period. A shorter subscription period protects issuers and investors alike from long exposure to market movements, which is particularly crucial in volatile times.