In what is a reflection of the ultra-competitive nature of the Asian convertible bond business, controversy erupted on Friday over HDFC's $500 million debut CB issue.
Competitor banks were quick to criticize the deal and question the lead managers' announcement that the issue was two times subscribed. They pointed out that the deal had to be reoffered at 98.5 - which meant the four lead managers had lost around $2.5 million on the trade. They also asserted that a large portion of the deal was rumoured to be sitting on the four banks' proprietary trading desks. Surely, they asked, if the deal was two times covered, there would be no need for the lead managers to be holding around $40-50 million each?
The critics believe the deal was not widely distributed and reckon the trade was driven by one anchor investor out of Europe that bought $100 million.
Meanwhile, the lead managers - ABN AMRO Rothschild, Barclays Capital, Citigroup, and JPMorgan - did not deny that in reoffering the deal at 98.5, they had lost around $625,000 each. But they stood by their announcement that the deal was two times subscribed. "This was basically a franchise transaction," said one of the lead managers. "There was a lot of competition to get this deal - since it is the first convertible bond for a bank out of India - and many of our competitors are upset not to have won. That explains the criticisms they are levelling."
The deal, which has a conversion premium of 55.6% and a yield to maturity of 4.62%, is the largest convertible bond ever from India, and is likewise the largest from Asia this year. New regulations in India now allow banks to issue convertible bonds, and this deal is expected to be the first of several to hit the market from Indian banks. It is for that reason that this is considered to be a "franchise transaction".
The lead managers say they took a very aggressive view on the bond, and while they would not confirm the amount of the deal sitting on their prop desks, it is reckoned to be about $160 million. However, one source said these prop positions were not taken because of lack of demand for the bonds but because the proprietary desks believe these bonds will trade well in the coming months and that the trading gains can be used to offset the underwriting loss.
The lead managers have an optimistic view on HDFC's stock and the Indian housing sector - to which HDFC lends.
And HDFC appears to have attained its objective and got very cheap funding from the trade. HDFC has no outstanding US dollar debt, but it is estimated that straight five year US dollar debt would have cost the bank 5.3-5.4%.
As one of the bankers involved noted: "HDFC is happy, and the investors who bought the deal are happy. We think this is an important deal for our franchises in India and so we were prepared to take the underwriting loss."
So are the rivals' criticisms unwarranted and just evidence of typical investment banker sour grapes? Well, in the sense that the only party that got hurt were the lead managers, yes. But the deal does have more unfortunate ramifications. What this transaction demonstrates is that with so much competition among banks to win deals, the economics of the convertible bond business have taken a battering. This HDFC transaction perhaps represents a new stage in that downward spiral - where banks are prepared to underwrite at a substantial loss in order to win key CB deals. This cannot be good news.