Merrill and CBA in dispute over failed placement

UBS completes the $1.1 billion share sale after CBA sacks Merrill Lynch on the basis that it failed to tell potential investors about new financial information.
Commonwealth Bank of Australia (CBA) and Merrill Lynch have become entwined in a public dispute over a failed share sale, which has sparked massive interest in the Australian media and is almost certain to lead to a wider debate about selective disclosures and what role investment banks should play on placements. Sources say a formal investigation by the regulators is also likely.

In a series of highly unusual events, the Australian bank cancelled a share placement arranged by Merrill after investors complained that they had not been told about an expected rise in CBAÆs bad debts. It also sacked and publically rebuked Merrill for not fulfilling its commitments, and then turned around and mandated UBS to re-do the sale at a lower price û all within a matter of hours.

It all began when CBA on Tuesday night issued a statement saying that it had completed a A$2 billion capital raising exercise through Merrill, including a A$1.65 billion ($1.1 billion) institutional share placement at A$27 per share. As part of the statement, CBA noted that it expects credit conditions to continue to deteriorate and that its bad loan ratio will increase to 0.6% of total loans in the current fiscal year to June 2009 û an increase of at least 20% compared with a forecast of 0.4%-0.5% last month. Investors who had committed to buy the placement immediately complained that they had not been informed about this new development and after an emergency board meeting on Wednesday morning, CBA decided to terminate the share placement and its placement agreement with Merrill on the grounds that the US investment bank had not lived up to its end of the agreement by informing investors of the various disclosures subsequently made by the bank in the Tuesday statement.

According to a CBA announcement yesterday morning, Merrill had been required, under the terms of the agreement ôto provide full disclosure to all potential investors before investors were required to commitö.

Merrill Lynch spokesman Rob Stewart in Hong Kong said the bank ôdoes not accept CBA's characterisation of eventsö. He declined to comment further, however.

Merrill will likely argue that it cannot selectively disclose information to investors that an issuer hasnÆt made available to the market as a whole, and that it was up to CBA to relay this bad loan ôwarningö to the entire marketplace in a timely manner. At least a couple of bankers argue though, that because the share placement was done after the Australian market closed, Merrill could have briefed investors on the new information without breaking any stock exchange rules û as long as the same information was also made available to the rest of the market before the shares started trading again, which it clearly was.

At this stage, it is unclear, however, what the exact agreements between Merrill and CBA were and whether Merrill was aware of all the new information when it started to market the placement. A Hong Kong-based lawyer says it is surprising that Merrill would get caught in a situation like this since placements are ôbread and butter stuffö for the bank and it should have been well up to speed on how to deal with potential new information. For one, it is up to the bank to guide the issuer on what ought to be included in the offering document and to make sure there are no surprises later on. This suggests that Merrill perhaps did not have all the facts.

At the same time, the lawyer says, it was hardly a second-tier issuer at the other end of the table, but one of AustraliaÆs biggest banks which has plenty of experience in doing placements and thus should have known how to approach the market with new information.

The fact that CBA has decided to so publically accuse Merrill for failing to live up to its end of the agreement does suggest that it is keen to shift the blame for the failed placement, but whether that is because it realises that it made a mistake and wants to deflect attention away from itself, or because it genuinely believes that the failure is MerrillÆs is impossible to tell.

What is clear is that CBA ended up selling its new shares at A$26 instead of at A$27, which means it had to issue more shares to reach the same deal size, resulting in greater dilution for existing shareholders. Someone is bound to have to answer for that.

Meanwhile, hearing that the share placement was falling apart, UBS approached CBA yesterday morning with a proposal to hard underwrite a deal of the same size at A$26 apiece û a discount of 10.8% to TuesdayÆs close, versus the 7.4% that was offered through the fully-covered Merrill placement. UBS got the job and completed the sale at a fixed price of A$26 in a few hours, while the stock was suspended from trading.

According to a source, many investors who had agreed to buy the shares the previous day were happy to subscribe at the lower price û despite the new information û and the book was oversubscribed with broad participation from both institutional investors and high-net-worth retail clients. All in all, about 150 investors participated.

The outlook for Australian banks isnÆt particularly positive in light of the strain on the commodities and real estate sectors, which is requiring them to set aside more capital to cover defaults and faltering loans û in fact, one market participant argued that investors shouldnÆt have been surprised by the rise in bad loans since there are plenty of signs that this was coming. Of the 16 analysts who cover CBA, only two have a buy recommendation on it, despite the fact that the share price has fallen 51% in a past year and hit a 12-month low of A$28.05 on Monday. The other recommendations are divided equally between holds and sells.

However, the placement was quite small at only about 4.5% of the existing share capital and about 10 trading days based on daily volumes over the past six months.

CBA has come under additional pressure after it agreed in early October to acquire Bank of Western Australia and St AndrewÆs Australia from struggling UK lender HBOS, even though the terms of the transaction have been viewed as quite favourable. According to Fitch Ratings it paid 0.8 times book and the deal is also expected to be immediately accretive on an earnings-per-share basis. Still, the share price has fallen about 35% since the acquisition was announced.

The bank said part of the proceeds from the latest capital-raising is meant to ôallow the group to take advantage of organic growth opportunities arising in the current marketà(and) to maintain its strong capital position throughout the current economic slowdown and deteriorating credit conditionsö.

In TuesdayÆs statement, CBA said volume and revenue growth for both loans and deposits have remained strong in the two months since its latest quarterly update in September and following the share placement, it expects its tier-1 capital ratio to be about 8.5% at the end of this year, up from 7.6% at the end of September. It added that it expects the demand for its balance sheet to remain strong into 2009 as international banks are reducing their exposure to the domestic Australian market.

To meet its capital needs, which also include the redemption of its PERLS II securities in March 2009, CBA engaged Merrill Lynch on December 10 to raise up to $750 million from a share placement that was to be done in portions over a period of up to 10 days and based on the daily volume-weighted average price. Demand for that share sale had been quite strong and led to the decision by the company early this week to do a larger placement in one go instead û thus the A$1.65 billion trade.

CBA said yesterday that it had raised A$357 million from the VWAP placement at a price of A$28.37 per share so far, bringing its total capital raising to A$2 billion. The remainder of the VWAP sale has been cancelled.

The Australian follow-on market has been one of the most active globally in recent months and Australian banks have raised about $7.7 billion since the beginning of September to shore up their capital bases, according to Dealogic. CBA itself did a $1.4 billion placement in early October in connection with the acquisition from HBOS. That deal was lead by Citi, CBA itself, Credit Suisse and J.P. Morgan. National Australia Bank has recently raised A$2 billion and Westpac A$1.6 billion.

UBS leads DealogicÆs ECM ranking for Australia this year with a market share of 21%, followed by Goldman Sachs and J.P. Morgan. Merrill Lynch is fourth with a 9.9% market share.
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