An emergency fundraising by HBOS, Britain's biggest home lender, flopped as investors took just 8.3 percent of the shares, leaving underwriters trying to sell almost 3.8 billion pounds ($7.57 billion) of stock.
HBOS, the latest UK bank to raise capital to repair its balance sheet and brace for a tough UK economic outlook, said on Monday its shareholders subscribed to buy 124 million shares in a 4 billion pound underwritten rights issue.
That left underwriters Morgan Stanley and Dresdner Kleinwort with 1.375 billion shares, one of the biggest blocks of shares left with investment banks since the privatization of oil major BP flopped in the middle of a stock market crash in 1987.
Britain's rights issue process now faces scrutiny, as HBOS rivals Royal Bank of Scotland and Bradford & Bingley also had a turbulent time during fundraisings.
Regulators have set up a working party to assess and report this year on the efficiency of process.
HBOS was hit by a weak stock market and economic jitters.
It offered its shares at 275 pence each in the issue, but its share price fell below that level in the days before the offer deadline, reducing the incentive for institutions and its army of 2.1 million private shareholders to sign up.
"The obvious reason (for the low demand) is the shares spent much of the time leading up to cut-off underwater," said Richard Hunter, head of UK equities at brokerage Hargreaves Lansdown.
"But it's also investors taking a view on the UK property market, which is a decision for the steeliest investors given where we are...there's a risk aversion," Hunter added.
The investors who didn't participate in the rights issue will see their shareholdings diluted.
HBOS shares closed 5.9 percent lower at 265.25p.
Dealers said the prospect of such a big stock sale could overhang the shares for some time, but support was provided by covering of short positions by speculators.
Left With The Shares?
A poor take-up of less than a quarter had been expected after a collapse in HBOS shares in recent months -- the offer had been priced at a 45 percent discount when announced on April 29 -- and concerns about UK bank prospects as the housing market slows and the economy falters.
Morgan Stanley and Dresdner are estimated to have sub-underwritten about 40 percent of their holding, but that would still leave each of them with over 1 billion pounds of HBOS shares, or an 8 percent stake.
They would have hedged much of their remaining exposure and lined up institutional investors to mop up stock at a discount, bankers said.
The extent to which they have long-term buyers lined up could dictate how the stock overhang affects HBOS's share price.
"What it comes down to is how much was underwritten by people who genuinely want to own the shares, in which case that stock won't overhang the market, and how much is left with those who don't want to own the shares, the prime underwriters," said James Hamilton, analyst at Numis Securities.
Many hedge funds and other speculators also sold the shares short in anticipation of buying it back now, so they will also absorb stock.
"There were a large number of hedge funds who shorted the stock with the intention of buying it back off the underwriters at a discount and it looks like they're going to get their way," Hamilton said.
Morgan Stanley and Dresdner have until Tuesday to sell the stock at above 275p, after which they are on the hook to buy any unsold stock for themselves.
"The rights issue was conducted in the middle of a fierce financial storm, we saw unprecedented volatility in bank stocks," said Shane O'Riordain, a spokesman for HBOS.
"The bottom line from an HBOS perspective is we've raised 4 billion pounds of capital, which means we will now be one of the most strongly capitalized banks. That's where we want to be at a time when the economic outlook is darkening," he added.
HBOS expects the fundraising to lift its core tier 1 capital to the "upper end" of its targeted 6-7 percent range by the end of this year, above most European peers.