Terms for a $120 million credit enhanced convertible for electricity distributor BSES (Bombay Surburban Electric Supply) were released by lead manager Standard Chartered at the beginning of this week.
The five-year deal represents the first equity-linked offering from India in nearly two years following Gujarat Ambuja Cements in January 2001 and only the second deal in nearly five years. As such it had huge rarity value and also marked an important mandate for the Standard Chartered team, which formerly dominated the credit enhanced market at Bank of America.
However, the lead's view of pricing and placement appears to be completely at odds with the rest of the market. Specialists argue that because terms were so aggressive no standard convertible investor would have touched the deal and that it must have, therefore, been placed through offshore Indian private banking channels. This is refuted by the lead, which says the deal was placed with buy and hold investors who liked the combination of credit protection and equity upside. The only agreement concerns the issuer and here everyone concurs that BSES got extremely cost efficient funding, saving 3% to 4% over its normal funding costs in the syndicated loan markets.
Terms comprise a 0.5% coupon, 15% conversion premium based on a 10-day average to Friday October 18, redemption price of 105% and yield-to-maturity of 1.6%. There is no put option, but the deal can be called after three-years subject to a 125% hurdle.
Underlying assumptions are said to be a bond floor of 88.62% and fair value of roughly 111%. The bond floor is based on a credit spread of 25bp over Libor and low double A/high single A rating achieved through the letter of credit (LoC) which backs the deal. Fair value calculations reflect a dividend yield of 2.1%, stock borrow cost of 5% and 26% volatility assumption. This latter assumption is based on the volatility of the domestic shares rather than the GDR, which is highly illiquid and has a much lower 90 day vol around the 13% mark.
Where the bond floor is concerned, most bankers argue that the real level should be a couple of points lower than 88.62% because the Libor spread is far too aggressive. Indeed on the day of pricing, Asian single-A rated credits such as the MTR and Republic of Korea were averaging spreads of 50bp to 60bp over Libor, and low double-A rated non-Asian credits about 10bp lower.
A wider credit spread assumption lowers the bond floor and most specialists say that in this case, the real bond floor is around 85% - a level which means investors pay 15 points for an equity option on a stock which is neither volatile or liquid and cannot be borrowed. Typically, investors would be unwilling to pay more than seven points for an unhedgeable stock and recently in Taiwan have baulked at more than five. This also means that even if the bond floor does reflect fair credit value at 88%, they are still having to pay 12 points.
Specialists also add that a bond floor of 88% when combined with a low volatility assumption, reasonable dividend yield and zero stock borrow equates to fair value below par rather than 111%. And as one banker points out, "If this is the case, why would any investor pay par for a deal that has a lower intrinsic value?"
Standard Chartered, on the other hand, says that books closed two times oversubscribed, with participation from about 15 accounts, with an even split between Asia and Europe. Most were said to be asset managers and private banks that liked the rarity value combined with the defensive aspects of the deal including the credit protection inherent in the single-A rating and utility status of the stock.
Less controversy surrounds the syndication of the LoC, where Standard Chartered was able to bring innovation to the market through its use of multiple fronting banks, rather than just one bank.
Historically one bank has fronted the LoC (Bank of America), but the current deal has six arrangers with a blended credit spread at the same low double AA rating that Bank of America used to provide. Standard Chartered by contrast has a mid single A rating.
Credit enhanced deals have proved popular with Indian issuers because most prospective issuers are too lowly rated to raise funds on a stand-alone basis. And unlike Taiwan where tech companies have similarly low implied ratings, there is not the same voracious credit appetite from domestic banks.
But the structure only works if the combined cost of the LoC and funding cost for the LoC bank is lower than the issuer's cost of funding on a stand-alone basis. Historically, Indian issuers have had to pay about 125bp all-in for the LoC, but in this instance, Standard Chartered has introduced a commission structure that rises each year and is ultimately tied to the level of conversion over the deal's five year maturity.
A $140 million LoC was syndicated in April, with arrangers offered a flat fee of 60bp and LoC commission of 60bp for the first year, rising to 85bp in the second year, 110bp in the third year, 125bp in the fourth year and 145bp in the final year. For the first year, this gave an all-in of 110bp.
At closure, the LoC had six arrangers, with Standard Chartered fronting 40% of the deal with a $50 million take, Aa1 rated Credit Agricole taking $15 million, alongside Aa2 rated DBS, AAA rated Rabobank, A2 rated Emirates Bank and Aa2 rated NordLB, which took $10 million..
Proceeds will be used to pre-pay more expensive World Bank loans and fund a $61 million purchase of three New Delhi power distributors.
