The lending opportunity in CYBG
30 October 2018
Sam Pierson of IHS Markit discusses how CYBG’s acquisition agreement with Virgin Money created an excellent opportunity for shareholders
Image: Shutterstock
• CYBG delivered $5.9 million in Q3 lending revenue
• Share price has declined 28 percent from a year-to-date peak on 8 August
• Meanwhile, shares on loan have decreased 58% since share price peak
• Merger activity and negative sentiment combine for an excellent lending opportunity
When CYBG announced an acquisition agreement with Virgin Money on 18 June it created an excellent opportunity for long-term CYBG shareholders who were willing to lend their shares. It also created an opportunity for arbitrageurs to profit on the collapse of the spread between the offer price, 1.2125 shares of CYBG per share of Virgin Money, with the initial offer implying a 6 percent premium to the price where Virgin Money shares were trading when the offer was formalised.
CYBG announced their intention to make an offer for Virgin Money in early May, at the time being granted until 4 June to formalise an offer. When CYBG issued a statement regarding the potential offer on 4 June, which announced an extension to the previous deadline, it was taken as an indication that a formal offer was forthcoming. The arbitrageurs jumped on the opportunity, adding more than 30 million shares to the short position in the subsequent three days. The spread narrowed slightly in the following days but remained in the 4.5 to 5.5 percent range until the deal summation came into sight in early September.
Lenders started to increase borrow fees on the initial surge in demand in mid-June, with borrow rates moving north of 250 basis points in late June, coinciding with the utilisation of lendable shares increasing to above 75 percent. With borrow demand increasing past 100 million shares in mid-August, the fees demanded by lenders continued to increase, topping out in the low double-digits for new borrows on 12 September, with utilisation at 95 percent.
The increase in fees came at the expense of the arbs, who must pay the borrow fee to remain in the trade. The peak fee observation immediately preceded the decline in borrow demand, with some combination of arbs and outright shorts deciding to start covering in late September, as the deal spread declined to just over 2%, and the price of CYBG itself declined 8% from the YTD peak.
The spread between the offer price and the price of Virgin Money in daily trading continued to narrow heading into the closing date on 12 October, and briefly inverted on 5 October. The narrowing of the spread prompted some intrepid short sellers to short Virgin Money as well, with the short position in that stock increasing from virtually nothing on 20 September to 19 million shares on 12 October. That trade worked as well, with the declining CYBG price weighing on the final value of the offer.
And a final farewell to directional short sellers and arbitrageurs has come in the form of the sell-off over the last two weeks of October, which has seen CYBG shares trade down 8.8 percent following the close of the acquisition on 12 October. All told the merger arbitrage would have yielded 5 percent depending on exact entry and exit, while being short CYBG from the announcement of 4 June would have yielded a return of 9.8 percent. In both cases, those numbers are gross of borrow fees, which would have offset the return by 170 basis points in realised borrow fees during that time.
The corollary is true for CYBG shareholders, who have seen a corresponding boost in the form of lending revenue. They also saw the value of their shares decline over the past six months, however, the decline in valuation for CYBG was similar to the major UK equity indices over that span, a broad holding of which would have delivered far less in realised lending revenue.
• Share price has declined 28 percent from a year-to-date peak on 8 August
• Meanwhile, shares on loan have decreased 58% since share price peak
• Merger activity and negative sentiment combine for an excellent lending opportunity
When CYBG announced an acquisition agreement with Virgin Money on 18 June it created an excellent opportunity for long-term CYBG shareholders who were willing to lend their shares. It also created an opportunity for arbitrageurs to profit on the collapse of the spread between the offer price, 1.2125 shares of CYBG per share of Virgin Money, with the initial offer implying a 6 percent premium to the price where Virgin Money shares were trading when the offer was formalised.
CYBG announced their intention to make an offer for Virgin Money in early May, at the time being granted until 4 June to formalise an offer. When CYBG issued a statement regarding the potential offer on 4 June, which announced an extension to the previous deadline, it was taken as an indication that a formal offer was forthcoming. The arbitrageurs jumped on the opportunity, adding more than 30 million shares to the short position in the subsequent three days. The spread narrowed slightly in the following days but remained in the 4.5 to 5.5 percent range until the deal summation came into sight in early September.
Lenders started to increase borrow fees on the initial surge in demand in mid-June, with borrow rates moving north of 250 basis points in late June, coinciding with the utilisation of lendable shares increasing to above 75 percent. With borrow demand increasing past 100 million shares in mid-August, the fees demanded by lenders continued to increase, topping out in the low double-digits for new borrows on 12 September, with utilisation at 95 percent.
The increase in fees came at the expense of the arbs, who must pay the borrow fee to remain in the trade. The peak fee observation immediately preceded the decline in borrow demand, with some combination of arbs and outright shorts deciding to start covering in late September, as the deal spread declined to just over 2%, and the price of CYBG itself declined 8% from the YTD peak.
The spread between the offer price and the price of Virgin Money in daily trading continued to narrow heading into the closing date on 12 October, and briefly inverted on 5 October. The narrowing of the spread prompted some intrepid short sellers to short Virgin Money as well, with the short position in that stock increasing from virtually nothing on 20 September to 19 million shares on 12 October. That trade worked as well, with the declining CYBG price weighing on the final value of the offer.
And a final farewell to directional short sellers and arbitrageurs has come in the form of the sell-off over the last two weeks of October, which has seen CYBG shares trade down 8.8 percent following the close of the acquisition on 12 October. All told the merger arbitrage would have yielded 5 percent depending on exact entry and exit, while being short CYBG from the announcement of 4 June would have yielded a return of 9.8 percent. In both cases, those numbers are gross of borrow fees, which would have offset the return by 170 basis points in realised borrow fees during that time.
The corollary is true for CYBG shareholders, who have seen a corresponding boost in the form of lending revenue. They also saw the value of their shares decline over the past six months, however, the decline in valuation for CYBG was similar to the major UK equity indices over that span, a broad holding of which would have delivered far less in realised lending revenue.
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