The bookrunner of the Reliance deal - Deutsche Bank - has refuted claims that it was mispriced and it is still sitting on a large chunk of paper.
Such a scenario is not uncommon in cases where several banks compete for the underwriting mandate. Of all Asian markets, India is the one where issuers appear to rule and banks commonly sacrifice their fees.
At the moment, the only losers from this development are the banks themselves and with the Indian stockmarket powering ahead at an accelerating pace, they have often been able to recover their initial losses or turn them into modest profits. Issuers are happy because they are able to raise funds at very attractive terms, while investors have been able to pick up the bonds at discounted prices.
However, some bankers argue that the keen competition for CB mandates may soon start to have repercussions for the broader market. The first sign of this is the fact that many of the recent CBs have been trading down as soon as they hit the market.
ôInvestors are becoming more demanding. If you have an issue that looks like it doesnÆt have value, then nobody is going to bid par for it,ö one banker says. ôThey will either say that they want it at 98.5 or 99 or they wonÆt be participating, and banks bringing a plain vanilla deal, unless it is a particularly special name, wonÆt have a huge amount of leverage with investors.ö
According to some bankers, the investor base is already changing for some of these Indian deals and many key CB investors, including Asia-centric hedge funds who have been in the game for a long time, are believed not to have participated in some recent offerings. Instead, these issues have been bought by fast money from the US or Europe which is looking for a quick exposure to India, and see CBs as a cheaper alternative to an option, one banker said.
It doesnÆt help that some investors are also becoming more cautious about the secondary market, where the Sensex index has rallied about 85% to a high of 11,146 points last week from about 6,000 points 11 months ago. The pace of the gains is also accelerating sharply with the jump from 10,000 points to 11,000 points taking only seven weeks, compared with the nine weeks it took to move from 9,000 to 10,000.
Such acceleration, some observers argue, is a classic sign that a bubble may be building and suggests the peak is getting closer. As a result, investors are likely to be less and less willing to accept conversion premiums in the 40%-50% range, which will put additional pressure on the CB market as long as the banks continue to grant issuersÆ wishes for high conversion premiums and low yields.
What individual banks are willing to offer when they bid for a mandate does depend on how they view the issuerÆs credit and the equity story and on its relationship with the client. According to some CB bankers, however, the low-end bids for some recent issues have been so tight that it has been clear from the beginning that the bonds would never sell at par and that the banks submitting those bids would make a loss on the transaction.
The reason why the market has ended up in a situation like this is obvious. IndiaÆs importance is growing û within the CB space and equity capital markets overall û and everybody wants a piece of the pie.
ôThere has been a number of marquee transactions, all of which have been very, very competitive and a number of banks have been looking at these from a franchise perspective and from the perspective of building a business,ö said one banker. Typically, seven or eight banks will be bid for these mandates, he added.
The thinking is that once a bank is on the radar screen as having arranged a large deal it will be considered for a number of other potential transactions that could end up being more profitable.
ôItÆs not just about fees any more, itÆs about league table credits and market share and about wanting to be a big player in the most important market,ö argued another banker.
According to Dealogic, India has accounted for 58% of total equity-linked issuance volumes in Asia ex-Japan this year, compared with 23% last year. But while this can be seen as a powerful incentive for having a significant presence in the Indian market, one could also argue that it makes little sense to do 58% of all deals if you make no money.
The current trend is seen to have started with the $500 million CB from housing lender HDFC in August last year, which at the time was the largest ever convertible out of India. The issue was also significant in that it was the first foreign currency CB from IndiaÆs financial sector following regulatory changes that made such issuance possible.
The desire to be associated with such a landmark transaction led to keen competition for the mandate and the bond was brought to market with a hefty conversion premium of 55.6% and a yield to maturity of only 4.62%. When the bonds had to be reoffered at 98.5%, the four underwriters lost about $625,000 each.
Like with the Reliance deal, other banks questioned the accuracy of the underwritersÆ claim that the HDFC issue had been two times covered and said bonds were almost certainly left on the bankÆs proprietary desks.
This yearÆs examples of major Indian bonds that have either had to be re-offered or have immediately traded down û and thus brought accusations of being mispriced - include a $120 million issue from consumer electronics maker, Videocon Industries; a $440 million issue by pharmaceutical company Ranbaxy Laboratories; a $125 million issue by construction and engineering contractor, Punj Lloyd; and a $75 million offer by shipping and agricultural company, Sical Logistics.
The largest of them all û a $750 million deal for London-listed metals and mining group Vedanta Resources û also struggled to find buyers at launch after underwriter Barclays Capital agreed to include an unusual conversion feature that many investors found hard to stomach.
The banks involved will argue that each of these deals had its own quirks and that there is a big difference between just sacrificing oneÆs fees and to be left with a big chunk of bonds. However, the fact that both these scenarios are now occurring more frequently does indicate the market is not altogether healthy.
Barclays, Deutsche Bank and Citigroup are widely regarded as being the most aggressive when bidding for Indian CB mandates, and as of March 10 these three were also at the top of DealogicÆs Asia ex-Japan league tables with 26.7%, 20.9% and 18.4% of total issuance volumes respectively.
JPMorgan, which topped the league table in 2005, is fourth this year with a 6.6% market share.
However, other banks too have proved competitive on certain issues or have at least been willing to match the accepted lower bids to get joint bookrunning positions on key transactions.
The HDFC deal was led by ABN AMRO Rothschild, Barclays, Citigroup and JPMorgan; Videocon was brought to market by DBS and Lehman Brothers and Ranbaxy was underwritten by Citigroup, Deutsche, Morgan Stanley and UBS. Punj Lloyd was brought to market by Citigroup, while Deutsche Bank was sole bookrunner for Sical.
While there is still downward pressure on fees, more often investment banks compete by promising to complete deals at a yield that is at the tight end of what the market is likely to accept if the bonds were to be issued at par.
ôItÆs a sign of Asia being overbanked and that banks are spoiling the market,ö one observer said. ôBut deals like Reliance do take away investor appetite and I hope it works as a warning to all banks not to be stupid about it.ö
If so, it could lead to the CB market adjusting itself back to more normal levels where banks actually make money on their trades and issuers will be forced to adjust their expectations downward to levels at which investors feel they get reasonable compensation for the amount of risk they take on.
For now though, enough investors remain optimistic about the prospects of the Indian stockmarket for there to be buyers of the CBs when they are offered at a discount.
Indeed, even though valuation multiples have been going through the roof in the past year, many analysts remain comfortable with the technicals of the stockmarket and argue that India is still flush with domestic liquidity, which should allow the current uptrend to continue for a while yet.
If that turns out to be the case, investment banks will continue to get bailed out by the market performance leaving little incentive for them to change their current behaviour.
The irony of this whole situation, of course, is that many of todayÆs lossmaking and franchise building transactions could prove to be worth little to the banks - indeed if issuers simply continue to give the mandates to the lowest bidder, what's the point of franchise building?