* Underwriters buying large blocks of stock before lining up
* Private equity firms often push "bought deals"
* With IPO volume low, banks feel pressure to do these deals
By Olivia Oran
Nov 27 Investment banks, desperate to win
business as stock issuance volumes dwindle, are taking on more
underwriting risk by buying large blocks of stock from U.S.
companies before lining up investors to take the shares.
These stock purchases, known as "bought deals," account for
23 percent of secondary share issues from publicly traded
companies so far this year, up from 15 percent last year. It is
the highest level since the financial crisis flared up in 2007,
according to market data firm Ipreo.
Typically, investments banks conduct a marketing road show
to line up investors for a share offering before signing an
underwriting agreement with a corporate issuer. Banks get a
percentage of the proceeds as their underwriting fee, averaging
about 5 percent.
In bought deals, banks sign an underwriting agreement before
looking for investors and buy the shares from the company
outright - which means banks can be stuck with the stock if
prices fall. There is no fee as banks get the shares at a
discount to the market price, usually 2 percent to 5 percent.
Bought deals offer banks lower profits - a concern for some
analysts, who say underwriting is one of the few profitable
investment banking businesses as merger volumes slump and
regulations crimp trading profits.
"If they shift the equity capital markets business it's
going to push down the returns of one of the few good markets
left on Wall Street," said Brad Hintz, an analyst at Sanford
Bought deals have historically offered banks a profit of
roughly 2.3 percent of the issuance amount, which is about half
of that of a fully marketed secondary share offering, said Jay
Ritter, a finance professor at the University of Florida.
Companies like bought deals because they can sell shares
faster at a guaranteed price. Typically, a company asks
underwriters to bid on a block of shares - say, a million - by
the end of the day. The bank that bids the highest price, which
means accepting the smallest market discount, usually wins.
The bank then tries to sell the shares quickly and for a
profit, usually by targeting existing investors who are already
comfortable with the company. But if market prices plunge after
the underwriter buys the stock, the bank loses money.
Many of the companies taking advantage of bought deals are
owned by private equity firms, which have large portfolios of
stocks to sell and can use their weight as big Wall Street
clients to pressure banks to bid on the deals.
Banks are susceptible to pressure now. Fees for U.S. listed
IPOs, traditionally the most lucrative source of profit from
stock underwriting businesses, have fallen 20 percent so far
this year to $1.7 billion and are on track to drop to their
lowest level since 2009.
Doughnut seller Dunkin Brands Group Inc and natural
gas pipeline operator Kinder Morgan Inc are among the
private equity backed-companies that have been involved in big
bought deals this year.
"Are these deals a necessary evil? I don't know," said one
equity capital markets professional who declined to be
identified because he is not authorized to speak to the press.
"But no one likes taking on unnecessary risk."
One factor that has helped underwriters in the United States
this year: the market has generally risen, with the Standard &
Poor's 500 index up more than 10 percent for the year and the
volatility index trading below its historical average.
In Europe, where markets have struggled this year, some
banks have been left holding stock after the deals failed to
In February, Morgan Stanley was stuck with almost
half of $1 billion worth of shares of Danish phone company TDC
A/S after failing to attract sufficient investor
interest. Morgan Stanley has since sold the shares, according to
a source close to the situation. The bank declined to comment.