What it means
When banks combine to underwrite a new issue, the agreement among underwriters must settle one awkward question: who pays if some securities cannot be sold? In an undivided account, the answer is that everyone pays together.
Unsold securities are shared among all members in proportion to their percentage commitment. The word undivided refers to the liability, which stays pooled rather than split into separate allocations.
A bank with a 10% participation is responsible for 10% of whatever remains unsold, even if it has sold every security in its own allocation. The syndicate manager normally holds the unsold securities and distributes them to members as needed.
This structure protects the issuer and encourages cooperation. Because all members share the leftover risk, none benefits from selling only the easy securities and leaving the hard ones to others.
It also lets the lead manager direct sales to wherever demand is strongest, without worrying about whose allocation is whose. The cost is that strong sellers can end up carrying risk caused by weaker ones.
Banks with large distribution networks sometimes prefer a divided account because they are confident of selling their own share. For that reason the choice between the two structures is part of the negotiation when a syndicate is formed.
Terminology can vary. The account type is set out in the agreement among underwriters, and market practice differs between regions and between equity and bond deals.
In practice many modern deals use arrangements that blend features of both. Banks should also consider the balance sheet effect.
During the offer period a member may need to hold unsold securities on its trading book, which uses capital and funding, so it should plan for that possibility from the start. The risk is greatest in volatile markets, when unsold securities can fall in value before they are placed.
In practice
Real-world examples.
Example
A $300,000,000 bond issue is underwritten through an undivided account by five banks. When $30,000,000 of bonds remain unsold, each bank takes a share of those bonds in line with its participation, not according to which investors it approached.
Example
A well-connected regional bank sells its full allocation of a share offering within a day. Under the undivided account it still has to take 10% of the remaining shares because its participation is 10%.
Example
A syndicate manager chooses an undivided account for a volatile deal because it wants flexibility to redirect shares to whichever bank's clients show interest on the day. That flexibility is the main practical advantage of the structure.
Formula
Calculation
Member's liability for unsold securities = Unsold securities x Member's participation percentage
A syndicate underwrites 10,000,000 shares at $10 each, a $100,000,000 issue. Investors take 8,000,000 shares, leaving 2,000,000 unsold, worth 2,000,000 x $10 = $20,000,000.
A member with a 25% participation is liable for 25% x 2,000,000 = 500,000 shares, which is 500,000 x $10 = $5,000,000.
This applies even if that member sold all of its own allocation of 2,500,000 shares.
In a divided account the same member would be liable only for any unsold part of its own allocation, which in this case is zero. In the undivided account, the four equal members would together carry 4 x 500,000 = 2,000,000 shares, which equals the full unsold amount.Case study
Seen in the real world.
Stonebridge Capital is an illustrative, fictional investment bank that joined a four-member syndicate with a 20% participation in a $250,000,000 share offering. It had strong relationships with pension funds and sold its entire allocation of $50,000,000 in the first two days.
Two other members struggled to place their shares, and $25,000,000 of the issue remained unsold at the end of the offer period. Because the deal used an undivided account, Stonebridge had to take its 20% share of the leftover, which was $5,000,000 of shares, despite having already done its job.
Stonebridge's management disliked the outcome but accepted that the same structure would have protected it had its own allocation been the weak one. The illustrative story explains why banks read the account type carefully before they sign. The bank's risk committee now reviews the account type for every syndicate deal before approving participation.
Watch out
Common mistakes.
- Assuming each member only answers for the securities it was supposed to sell.
- Mixing up undivided and divided accounts, which allocate unsold risk in opposite ways.
- Ignoring the account type when estimating the capital a bank may need to hold during an offering.
Questions
People also ask.
What is another name for an undivided account?
It is often called an Eastern account, and the divided version is called a Western account.
Who benefits from an undivided account?
The issuer and the syndicate manager, because members cooperate and unsold securities can be placed flexibly.
Does an undivided account guarantee the issue will sell?
No, it only decides how unsold securities are shared among the banks; the demand still has to be there. In practice, check the agreement among underwriters to see which structure applies, since the label alone may not reveal every detail.
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