Lead manager Goldman Sachs found itself faced with one of the most unenviable execution jobs of the year yesterday (Wednesday) as it tried to clear a $700 million convertible for Cathay Financial Holdings. Pricing of the deal, which sets a new record in terms of size, not only came at the widest end of all its indicative ranges, but the bonds were also offered out to investors at 99% rather than par, meaning that the lead sacrificed most of its fees in order to complete it.
Taiwan has become one of the chief battlegrounds in Asian investment banking and the recent creation of holding companies in the domestic banking sector has been viewed as a potentially lucrative new source of revenue at a time when every firm's cost base is under severe pressure. For Goldman, which already has an extremely strong and successful franchise in the Island Republic, Cathay Financial was seen as a prize worth winning since the bank has the strongest credit profile of any of its peers and its deal size promised to swamp all that had come before it.
However, in order to prise the mandate away from Cathay's house bank JPMorgan - itself an aggressive competitor when it comes to winning new business - Goldman and the other banks which pitched for the deal had to offer tighter terms and reduced fees. Where normally a convertible would yield a fee of 2.5%, some believe that the Cathay deal has paid as low as 0.75%, although those closer to the company say that the actual figure is nearer to 1.25%.
Having won the deal and agreed to hard underwrite it, Goldman ended up being boxed into a corner after market conditions weakened and the issuer appears to have denied it the flexibility to amend the terms or adjust the issue size. Furthermore, because the fee was so low, it decided to retain sole control of the syndicate, leaving it faced with the prospect that all of its competitors would start shorting the bonds in the grey market.
It was, therefore, placed in an all but impossible position as grey market pricing slid from par to as low as 97.75% over the course of the two-day bookbuild. Other banks, confident that that the large deal size and aggressive terms would make oversubscription unlikely, took a view that they would not get squeezed and progressively bid the bonds down.
Final terms comprised a five-year final maturity, with a zero coupon, 20% conversion premium to an NT$50 close and yield-to-maturity of 2.75%. There is also three-year hard no call, thereafter subject to a 130% hurdle and three-year put at 108.54%. Premium redemption is at 114.53%.
Underlying assumptions comprise a bond floor of 91.7% and implied volatility of 25.9%. This is based on a credit spread of 140bp over Libor, zero dividend yield (the deal incorporates anti dilution protection), stock borrow cost of 4.5% and historic volatility assumption of 42.8%.
Books were said to have been fully covered with a geographical split, which saw 50% of bonds placed in Europe, with the balance split equally between Asia and the US.
For most observers, the hot topic of debate was whether the lead made or lost money on the trade. Based on fees of 0.75%, it would have lost at least $2 million from placing the bonds at 99%. If, however, the actual level is 1.25%, then the bank has still made up to $1.75 million depending on what position it holds itself and where it can trade out of it.
The three biggest challenges for the transaction were its large size relative to outstandings in the Taiwan market, its low bond floor and lack of stock borrow. Where the issue size was concerned, Cathay had already publicly stated that it intended to raise up to $1 billion making it very difficult for the lead to start out with a smaller deal size and then build momentum. Many observers believe that had it been able to adopt this latter strategy it would have been possible to clear the deal on aggressive terms and Cathay would have followed Fubon's lead in setting a successful benchmark for itself.
To win the mandate, Goldman also had to structure a deal with a lower bond floor than any its competitors, but found that investors were unwilling to pay up to 10 points for the equity option when there is virtually no stock borrow. Some investors would have taken a view that the bank may soon issue an ADR. Others set up hedges against relevant futures contracts such as the MSCI traded out of Singapore or the domestic banking index traded out of Taiwan. But for a deal size of $700 million, it was always going to be challenging to cover it fully at two to three points inside the level achieved by Fubon just over a month ago.
On the positive side, Goldman has now been responsible for three out of four of the largest equity-linked deals to come out of Taiwan, having previously led a $350 million convertible for TSMC and a $345 million offering for Hon Hai. It also managed to close a deal that is 87% larger than the previous record holder at a time of much weaker market conditions. And while the Taiwanese market has been under pressure over the past couple of weeks, Cathay's stock has managed to hold up, having fallen 2.9% since the deal was filed against a 3.9% drop for Fubon and a 4% drop for the overall Taiwan Banking Index.
Ultimately Cathay has succeeded in getting the terms it wanted. Yet most would probably argue that had it shown some flexibility, it would have been able to achieve aggressive pricing and a satisfying secondary market benchmark.