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FT editor Roula Khalaf picks her favorite stories in this week’s newsletter.
“A monkey without nuts could do your job,” studio mogul Les Grossman (played by Tom Cruise) tells his colleague in the 2008 film. tropical storm. “Now go get drunk and take credit for all the parties.
The sentiment reflects how investment bankers sometimes feel when a challenger wins a coveted mandate. Many capital markets jobs do not require special skills to perform, but can be extremely lucrative for the lead underwriter.
Last Thursday, National Grid announced a colossal £7bn fully subscribed rights issue to help fund a £60bn five-year investment plan. This is massive: the biggest equity offering of the year and the biggest in the UK since Lloyd’s Bank bailout in 2009.
It also means a massive payout for the two major banks, Barclays and JPMorgan, who stand to receive up to £140m in underwriting fees. It’s hard to overstate what a home run this deal was: it’s virtually unheard of to earn a $90 million fee for a single stock offering, let alone $4.5 billion in league table credit.
The deal structure is straightforward – a fully subscribed, deeply discounted rights issue. Shareholders acquire rights (in a ratio of 7 for 24) to purchase new shares at a discount of 35%. There is nothing creative here; the deal is as plain vanilla as Robert Van Winkle. Barclays and JPMorgan guarantee returns if there is any shortfall. No other bank is involved and – contrary to UK rights-issuing standards – none of the offers are underwritten by institutional investors.
Bankers at Barclays and JPMorgan hit the jackpot and secured yuga minimal risk fees. In discussing Credit Suisse’s near-disastrous rights at the end of 2022, FTAV wrote:
The vast majority of rights issues are anticlimaxes. As long as the shares remain well above the subscription price, shareholders have every incentive to exercise this right and buy the shares at a discount. And since the underwriting banks aren’t actually selling the stock, there’s none of the stress or uncertainty of gathering orders and building a book of investor demand like there is with an IPO or equity placement. …. [A] the steep discount is why some investors disparage the fees banks earn for underwriting as “money for old rope”: the underwriters pocket a fee for taking on the very remote risk of staying with the stock.
Business with National Grid will be hard for other banks to swallow. Investment banking executives will conduct ruthless investigations of trustees, especially if their banks loaned money to National Grid in anticipation of a big payday. At least a dozen full-service investment banks could underwrite this offer, and so there will be general frustration.
Lending banks weren’t the only party left in the cold. Normally up to 30-50 per cent of a UK rights issue is sub-subscribed to UK shareholders who collect around a 1 per cent fee. Not here. Barclays and JPMorgan were comfortable with the risk and did not want to share their fees with institutions. And National Grid didn’t insist on sub-underwriting either.
It is worth asking why National Grid insulted its creditors and shareholders to favor Barclays and JPMorgan to such an extreme. But the fact that there was no sub-signing probably doesn’t really matter much.
The fund manager’s investment decisions are not subject to the sub-underwriting fee. The practice of paying out sub-underwriters is largely a British phenomenon and has long seemed anachronistic, a holdover from a bygone era when the “UK Club” of marquee fund managers had some power. This rights issue shows that the UK investor community is now seen as a spent force that no longer needs to be appeased.
Foreclosing on creditors, however, is a different story. Companies typically split fees to ensure ongoing support from lending banks. National Grid had £140m in play fees and Barclays and JPMorgan would be content with a fraction of the fees they ended up receiving, especially if they kept the £7bn credit from the league table. So why enrich them with the entire pool of fees?
Part of the reason may be corporate brokerage – a unique British practice. Companies listed in London appoint (usually) two banks as corporate brokers to act as capital markets advisers. Corporate brokers for FTSE 350 companies usually work for free and hope to gain an M&A or capital markets mandate in the future. Corporate brokerage assignments are the closest thing to a “captive” client situation you’ll ever see in investment banking.
Another reason is more practical. National Grid took the deal by surprise in the market and likely did not want to risk a leak or distract their internal teams working tirelessly to prepare for the launch. This is understandable, but in such cases, companies often offer subscription slips immediately upon notification, along with due diligence materials and take-it-or-leave-it documentation. Even if the banks only have a day to respond, they will be on time with their underwriting.
From the outside looking in, it’s surprising that National Grid showered their two corporate brokers with such a bounty. Sure, there’s something refreshing about rewarding trusted advisors with “dumb money” from lending banks. Additionally, Barclays and JPMorgan have probably done a lot of free corporate finance work over the years.
However, it is doubtful that the value of this work will come close to the fees awarded. And it’s hard to see the upside of alienating creditors you might need in the future. Banks will not cut credit lines hastily, but there is no doubt that they will scrutinize future loan applications more critically to determine whether they will earn sufficient ancillary fee income to justify the commitment.
Another tricky question concerns the spread of fees – 1.85 percent of the base fee plus an incentive fee of 0.15 percent. As FTAV has discussed elsewhere, underwriting rights is akin to writing deeply paid money – National Grid effectively has until June 12 the right to sell £7bn worth of shares to Barclays and JPMorgan at 645p. But the ‘option’ is so big, so custom and so unhedged as to render valuation by the Black-Scholes model absurd.
It’s really anyone’s guess what the underwriting “value” is. Fees here are roughly in line with UK practice and are around 50-75bps higher than continental European rights issues. However, since Barclays and JPMorgan were given the full economic and league table, National Grid has been able to push charges harder. Much much harder.
The two leaders would probably accept, say, 1.25 percent. Perhaps a £50m saving is a rounding error for a company set to spend £60bn on investment – especially when it’s not your money – but it seems odd for UK investors to make such a fuss about CEO pay when larger sums are splashed out for door. with less control.
A no-nonsense monkey – with a lot of discretion – could underwrite this rights issue, but the real skill in this deal was convincing National Grid to pay full fees and exclude other key partner banks.
Whoever the bankers are: Feel free to go get drunk and take out loans for all the parties. Even Les Grossman would think you deserve it.