From the Lending Desks: Equities

Q3 marked a volatile quarter for the equity markets. Concerns about a double dip recession, continued uncertainty about peripheral European sovereign debt, the strength of the EU banking system, and credit tightening in China, all contributed to risk aversion among investors, who sought refuge in Government bonds, and currencies such as the Yen and Swiss franc, while selling equities and commodities. Sentiment did, however, turn more positive towards the end of the quarter leading to a rally in equity markets in September. Throughout July and August we experienced short covering resulting in loan returns and refinancing by borrowers. High revenue generating stocks that were negatively impacted included Banco Sabadell (Spain), Commerzbank (Germany), Raiffeisen (Austria), Galenica (Swiss), OTP Bank (Hungary) and Diamond Offshore Drilling (US). However, this trend was largely reversed in September with improved sentiment leading to increased lending activity driving balances and fees back up.

A long awaited pick up in M&A activity generated several lending opportunities. There was demand for Vedanta after it announced plans to buy a stake in Cairn Energy’s Indian unit and for Nedbank on the back of interest from HSBC of the UK. Deutsche Bank announced a takeover of Deutsche Post, and ACS, Actividades de Construccion y Servicios announced a bid for Hochtief of Germany, also capturing Leighton Holdings in the transaction (majority owned by Hochtief). The deal that everyone was talking about was BHP of Australia and their hostile bid for Potash of Canada. However, given the huge liquidity in BHP shares, there was no significant increase in borrowing demand.

Hedge fund performance continued to struggle this quarter, although across the industry estimates were for slightly positive returns, although not enough to recover losses in Q2.

Asia Pacific

Q3 was an active quarter for capital raising in APAC, with the Agricultural Bank of China Ltd IPO being the biggest news. Despite concern about weak markets and the size of the offer (World’s largest IPO) the stock rose on its debut. Demand to borrow was good, although fees started to fall as liquidity hit the market. Other capital raising deals that attracted good borrowing demand included PCCW Ltd, China Unicom, Ruinan Intl and China National Building Material in Hong Kong; Nippon Sheet Glass, Sawai Pharmaceutical, Mizuho Financial, Inpex Corp and Nippon Shokubai of Japan; and Mapletree Logistics and Neptune Orient Lines of Singapore. Japanese equities officially entered a bear market in August having fallen more than 20% from their April peak. Risk aversion, which is driving up the value of the yen, is hurting Japanese exporters and is reflected in weaker share prices. Balances increased significantly towards the end of the quarter as the Japanese September dividend record date approached, with borrowers switching out of high dividend domestic stocks into lower dividend international shares (so they pay a lower manufactured dividend to lenders). There was dividend activity in Singapore for the scrip arbitrage trade, with DBS being our largest position, and in Australian for the drip arbitrage with QBE and Brambles being notable transactions. In general, volumes and levels of activity in Asia picked up significantly in September, driven by capital raising and directional activity. The biggest revenue generating stocks across the book included Byd Co, Alibaba.com and PICC Property & Casualty in Hong Kong, HTC Corp, Acer and MediaTek in Taiwan, Inpex and Shinsei Bank in Japan, LG Household & Health Care in Korea, and Olam International in Singapore.

Europe, Middle East & Africa

In Europe there was no reaction in the lending market to the release of the bank stress tests. Borrowers had positioned themselves prior to the announcements with demand declining in some of the names that were expected to pass (e.g., Commerzbank of Germany) and increased interest in firms expected not do so well, such as Banco Pastor and Banesto of Spain. The results were positive for equity markets which rallied in the days following their release. However, after the initial relief, investors continued to have concerns about how tough the tests actually were, and over the general health of peripheral euro-zone economies. In September, Ireland announced its intention to split Anglo Irish Bank in two and ended the month having to launch another rescue package for its banking system. There is still a ban on short selling of Irish financial shares, so the negative news did not result in a big increase in borrowing activity. That was not the case in Greece, where after lifting the short selling ban in financial companies, stocks were in high demand by borrowers (e.g., EFG Eurobank, Alpha Bank,borrowers (e.g., EFG Eurobank, Alpha Bank, National Bank of Greece). In September, National Bank of Greece announced a rights and convertible bond issue generating additional borrowing interest. We also saw some interest in Polish financial stocks such as Bank Pekao and Bank Zachodni. In September Deutsche Bank announced a €9.8bn capital raising to finance its takeover of Deutsche Postbank and to bolster its capital position ahead of the Basel Committee on Banking Supervision announcement of tougher capital requirement rules. There was borrowing demand for Deutsche Bank, but given the shares are highly liquid, fees did not reach very high levels. Another big deal was ACS Actividades de Construccion y Servicios of Spain which announced a tender offer to acquire a majority stake in Hochtief of Germany. Both securities were in demand and over the course of the month we were able to increase fees on ACS making it one of our top earning stocks. There was also demand for Leighton Holdings of Australia which is majority owned by Hochtief on speculation it would be sold (or more recent speculation that it may pay a special dividend). Yield enhancement activity dropped off as the main European dividend season came to an end in Q3. However, there was activity in Netherlands with stocks such as Royal Dutch Shell, Arcelor-Mittall, Unlever and KPN, and in Spain with Repsol, BBVA and Banco Santander. The big name in France was France Telecom for its September 1 record date, and in Italy with ENI. In the UK the contentious IPO of UK retail distributer Ocado ended its first day of trading down and saw high borrowing demand as the shares were widely viewed as being over priced. UK scrip dividend lending occurred in stocks such as HSBC, Standard Chartered, Prudential and Kier Group. Clients that could guarantee a cash election achieved premium fees. The following were the top earning securities across the lending book: Aixtron and Commerzbank in Germany, OTP Bank (Hungary), Banco Sabadell, Bolsas y Mercados Espanoles and ACS Actividades de Construccion in Spain and Galencia in Switzerland.

Western Hemisphere

Borrowing activity was very slow in July and especially in August, but did recover in September as equity markets rallied. In August, General Motors announced an IPO one year after exiting bankruptcy, which will enable it to start paying back the U.S. Treasury. The deal is expected to come to market in November and we expect good demand to borrow shares. Also in August demand for the education sector increased amid allegations that companies had encouraged students to lie on their financial aid forms. Oil stocks attracted interest with demand in the BP ADR and offshore drilling companies such as Diamond Offshore and ATP Oil and Gas, all relating to BP’s gulf oil spill disaster. Deal and capital raising activity continued to be very light. Notable trades included Level 3 Communications and Genco Shipping & Trading, both convertible bond offerings. Directional borrowing interest increased significantly for Sears, which moved back to being our top earning U.S. special. Other big revenue generators included Strayer Education, PetMed Express, Tesla Motors and AIG.

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