Mumbai: With several companies planning initial public offering (IPOs), lending people money to invest in IPOs, or IPO financing, is becoming important, and brokerages and non-banking finance companies are showing more appetite for this than banks that are still wary of the business after an earlier rap on the knuckles from the banking regulator.
In 2006, the Reserve Bank of India (RBI) fined nine banks, including ICICI Bank Ltd, Industrial Development Bank of India Ltd, HDFC Bank Ltd, and ING Vysya Bank Ltd, for “misuse of IPO finance”. IPO financing is an important component of the stock market process and is critical to the success of share sales, especially when many IPOs hit the market within a short period of time.
Investors pay either part or all of a share’s price while applying for shares on sale and sometimes, because of high demand for some IPOs, they discover after two to three weeks that they have not been alloted any shares. By locking up their money, these investors are unable to invest in other share sales that are happening at the same time. IPO financing allows investors to apply for shares without fear of locking up their money. Interest rates on such loans range from 14% to 20% and loans are available for 15-21 days—the time it takes for shares to be allotted to investors.
After RBI’s decision, banks have been going slow on IPO financing and the business is dominated by non-banking finance companies and brokerages such as JM Financial Ltd, Edelweiss Capital Ltd, Kotak Securities Ltd, India Infoline Ltd, Indiabulls Financial Services Ltd, Religare Securities Ltd, Motilal Oswal Securities Ltd, IL&FS Investsmart India Ltd, and Sharekhan Ltd.
IDBI, however, plans to relaunch its IPO financing business this month after withdrawing from it in 2006 after RBI’s action. The provocation for the relaunch is a string of big-ticket IPOs in the offing. Reliance Power Ltd’s Rs11,700 crore IPO opens on 15 January.
Public issues (including IPOs and follow-on public offerings) could raise as much as Rs75,000 crore this year, according to New Delhi-based Prime Database, a company that collects and analyses data on the primary market. In 2007, 105 public issues raised Rs39,387.72 crore from the market.
Retails investors can apply for up to Rs1 lakh worth of shares on offer in public issues; between 30% and 35% of such issues is reserved for them, while 10% is reserved for non-institutional bidders, including high net-worth individuals (HNIs).
Some retail investors and HNIs borrow money for subscribing to new issues.
According to Amitabh Chakraborty, president, equity, Religare Securities, the participation in the IPO market is almost entirely financed by third parties such as banks and other firms. Religare charges 16-17% interest rate for IPO financing and Chakraborty said the company has earmarked around Rs1,000 crore for the Reliance Power IPO.
“Typically, a big-ticket IPO will generate huge interest in investors (and reduce chances of allotment). Hence, people opt for loans against their shares to fund such an IPO,” said Bakul Mehta, vice-president, India Infoline, a Mumbai-based brokerage. “We charge 15-18% as interest rate on IPO financing. The margin money is typically between 5% and 10% of the application amount,” Mehta added. This means for every Rs100 worth of investment in a new issue, an investor needs to put in Rs5-10.
Even those banks that loan money towards investing in IPOs are not as liberal as brokerages and finance companies. This is because they have to maintain a margin of 50% on such loans, according to RBI.
IPO financing is categorized among the capital markets operations of banks and most of them cannot use more than 5% of the amount of money they can lend for capital market operations.
“IPO financing constitutes a very small part of our total banking business,” said Siddharth Rath, head of capital markets at Axis Bank Ltd. According to Rath, banks do not find IPO financing very “profitable because of the various restrictions they have under capital market exposure.”
The default rate in this business is almost zero as in most of the cases customers do not get more than 10% of the shares applied for. This means banks and brokerages get their money back instantly.
Apart from IPO financing, investors also bankroll their IPO applications through other kinds of loans. An executive at IDBI, who did not wish to be identified, said there is a significant increase in queries related to loans against shares “just before a big IPO comes”. And a senior executive at a foreign bank claimed that some investors take personal loans to invest in IPOs. This executive also did not wish to be identified.
Ashwin Ramarathinam contributed to this story.