Banks' underwriting: Bang to rights
Two troubled rights issues should remind banks that underwriting is a discipline, not a formality.
A couple of recent rights issues have got many in the equity capital markets community a bit hot under the collar. Lonmin’s $407 million trade in December came as a shock to the system when the underwriting banks were left with unsold shares even after they had completed a rump placement.
The deal triggered talk of a reassessment of rights-issue risk, especially when it comes to names in troubled sectors like resources.
Then came Italy’s Saipem in February, attempting a €3.5 billion capital raise. Conducted against the backdrop of high volatility in the oil price and therefore in the company’s share price, the deal saw unwanted rights placed with other investors, but then unexercised as the live price fell below the subscription price for the trade. Underwriters ended up with €427 million of unsold shares. It’s easy to see why some bankers are getting jumpy.
Underwriters have generally been able to count on the rights issue process to provide them with steady fees that were often seen as money for old rope, to use the phrase beloved of ECM professionals at the moment.
Suddenly it all looks different. There are fears that banks might step back from supporting such deals or at least demand more compensation for stumping up for the risk.
Those in the market with long memories are even referencing the infamous BP privatization in 1987. That was a UK government sell-off, not a rights issue, but was done in the immediate wake of the Black Monday crash. The resulting losses as the UK held banks to their underwriting commitments forced some firms out of ECM for a while and undoubtedly led to the demise of routine hard-underwriting of such trades.
But there is little evidence that two sticky situations are going to prompt any sort of wholesale reappraisal of risk commitments in rights issues.
The model is not broken. Banks should instead look to the discipline of their underwriting processes to ensure that they are best positioned to advise and support clients, even when those clients may be struggling. That means ensuring that corners are not cut in the diligence around the shareholder register and that the market’s ability to absorb a heavily dilutive offering is not overestimated.
It may also mean walking away from a deal rather than piling in an attempt to boost a lending relationship’s return. But ultimately it means understanding that underwriting is always a discipline, never a formality.
If the experiences on Lonmin and Saipem have reminded the industry of this, so much the better.