Ever thought why the initial public offerings of many companies receive bids that are over 100 times the offer. Apart from the investor appetite and retail frenzy the biggest factor in work is margin financing of IPOs by banks and NBFCs.
July saw several records being broken in the IPO market as a whopping Rs 8.86 lakh crore were bid for IPOs of Rs 18,400 crore on offer. About 98% of the money came from margin financing. Zomato, with an IPO size of Rs 9,375 crore, got bids for Rs 3.58-lakh crore, a subscription of nearly 39 times.
How does it work?
Unlike for retail investors, there is no limit on HNIs and institutions bids in an IPO. HNIs have to put only Rs 1 crore of their own for a bid worth Rs 100 crore while the NBFC funds the remaining 99 per cent. With the lenders charging 10-15%, the cost is just Rs 20 lakh towards interest for Rs 100 crore bid for 3-5 days. With all IPOs listing above the issue price, the leveraged investor can exit on the opening day. With a spectacular listing like the Zomato that gave 63% returns, more players are attracted to the market. The risk of the IPO collapsing in the initial days is virtually absent due to the heavy bidding and grey market premium.
With 15 per cent of an IPO reserved for HNIs and 50 per cent for institutions, their allotment is often enough to cover their interest cost as their bids are extremely high. Self-funding and other sources of borrowing would further increase the size of the IPO financing market.
The fund raise
Bajaj Finance had raised Rs 27,200 crore since June 10, while Infna Finance, Aditya Birla Finance and Tata Capital have collected Rs 13,225 crore, Rs 11,380
crore and Rs 9,625 crore, respectively. Two JM Financial firms have together raised Rs 16,300 crore, while IIFL Facilities Services and IIFL Finance have garnered about Rs 11,600 crore, according to reports. Most non-bank lenders raised funds by issuing commercial papers in the primary market. These papers have tenures of seven to 10 days and yield to maturity between 3.7% and 5.8%.
The risk
Financiers insist the risk is limited since there is a margin for the lender in terms of shares. Normally, higher the funding cost, lower the chances of making money on the IPO after all costs are factored in. Investors need to pay interest on the entire amount borrowed and not on the amount actually allotted. That is why higher oversubscription works against borrowers as they have to have more interest on idle funds.
RBI proposal
The euphoria due to excess funding is leading to artificial demand and distorting IPO prices in the short term. While the funded investors exit on listing, serious investors get low allotments.
In January this year, the Reserve Bank of India had proposed to cap IPO financing by NBFCs to up to Rs 1 crore per person, a move which may lead to a sharp drop in bidding by high net worth individuals (HNIs) and a drastic reduction in subscriptions of offers.
Banks have a Rs 10-lakh limit on IPO financing and there is no such cap for NBFCs. “IPO financing by NBFCs has come under close scrutiny, more for their abuse of the system,” the RBI said in a discussion paper. “Taking into account the unique business model of NBFCs, it is proposed to fix a ceiling of Rs 1 crore per individual for any NBFC,” the RBI said. Market players said that RBI’s proposed rule would surely bring a break to highly subscribed IPOs.