How To Master Municipal Bond Underwriting
Issuing Municipal Securities
Prior to issuing any bonds, a municipal issuer must authorize the issuance of the bonds through a bond resolution and obtain a preliminary legal opinion. The bond resolution authorizes the sale of the bonds and describes the issuer’s obligations to the bondholders. The preliminary legal opinion helps to determine how the bonds may be offered.
Selecting an Underwriter
Municipal officials cannot effectively tend to their duties and try to find investors to purchase the municipality’s debt. As a result, municipal issuers will select an underwriter or a syndicate of underwriters to sell the bonds for them. There are two ways that the issuer may select an underwriter. An underwriter may be selected either through a negotiation with the issuer or through a competitive bidding process. Most revenue bonds are awarded to the underwriter through negotiation. In a negotiated underwriting, the issuer will select the underwriter and negotiate the best terms directly with them. Most general obligation bonds are awarded through competitive bidding. In competitive bidding the issuer will invite underwriters to bid on the terms of the issue by publishing an official notice of sale in the Daily Bond Buyer. The underwriter or syndicate, submitting the bid with the lowest net interest cost, or NIC, to the issuer, will be awarded the issue. The official notice of sale will include:
- Description of the Issuer
- Description of the Issue
- Dated Date
- Maturity Structure
- Date and Place of Sale. Including The Time of Sale
- Denomination of Bonds
- Call or Put Provisions
- Sealed Bid or Other Bidding Provisions
- Amount of Good Faith Deposit Required to Accompany all Bids
- Name of bond Council
- Paying Agent and Trustee
- Expenses Allocated to issuer or purchaser
- Terms of Delivery
- Criteria for Awarding The Issue
- Right of Rejection
Interested parties will submit bids based on their ability to market the bonds on behalf of the issuer. The underwriter is trying to provide the issuer with a competitive rate on their bonds while still being able to earn a profit by selling the bonds to investors. The official notice of sale does not include:
- The Yield to Maturity or YTM
- The Bond’s Rating
- The Name of the Underwriter
- The Amount of Accrued Interest
The municipal issuer prepares a bond contract for the benefit of the underwriter and issuer. The bonds contract includes:
- Bond Resolution
- Trust Indenture (If any)
- Applicable State and Federal Laws
- Any Other documentation regarding the issuer
These documents make up the bond contract and the issuer is required to adhere to all of the terms and conditions laid out in the various documents.
Creating a Syndicate
Most municipal issues are sold to raise a substantial amount of money. In order to assist with the marketing of the issue and to spread the risk of underwriting the securities, several investment banks will form a syndicate. The syndicate is a group of underwriters responsible for selling the issue. Firms participating in a syndicate, formed to submit a bid in a competitive underwriting, must sign the syndicate letter or syndicate agreement. The syndicate letter will disclose all fees and expenses including clearing expenses. Syndicate participants in a negotiated underwriting must sign the syndicate letter or syndicate contract. The syndicate agreement will contain:
- Each Members participation in the offering (member’s commitment)
- Method of Allocating Bonds
- Name of Managing Underwriter
- Management Fee and Spread
- Member Expenses and Amount of Good Faith Deposit
- Liability for Unsold Bonds
- Type of Syndicate Account, Eastern or Western
Each syndicate member is responsible for selling the bonds that have been allocated to them based on their participation. A syndicate member may also be responsible for selling additional bonds if another syndicate member is unable to sell their entire allocation of bonds. There are two types of syndicate accounts: an eastern account also known as an undivided account, and a western account also known as a divided account. In an eastern account, if any bonds remain unsold, all of the underwriters must assist in selling the remaining bonds in accordance with their commitment level, regardless of which syndicate member was unable to sell them.
Let’s assume that there are 3 investment banks participating in a syndicate to underwrite $10,000,000 worth of municipal bonds. The syndicate account is an eastern account and the investment banks’ commitment levels are as follows:
|Investment Bank||Commitment Percentage||Dollar Value of Bonds|
Even though investment bank “B” was responsible for the $1,000,000 of unsold bonds, they would only be required to sell 30% of the remaining bonds or $300,000 worth and the other syndicate members must sell the remaining bonds in line with their participation.
In a western account or a divided account, any unsold bonds are the responsibility of the syndicate member who was unable to sell their allocation. If, in the above example, the syndicate account was a western account, syndicate member “B” would have to sell all $1,000,000 worth of bonds that they failed to sell originally.
Syndicate members will engage in a series of meetings in order to determine the terms and conditions of their bid. The syndicate members must determine:
- The Underwriter’s Spread
- The Re-Offering Yield
- The Prices and Yields to be Submitted To the Issuer
If all syndicate members cannot agree unanimously, on one or more conditions, they must agree to accept the decision of the majority of the syndicate members. Only one bid may be submitted for each syndicate and it will be submitted by the lead or managing underwriter.
The Syndicate must determine the re offering yield that will be offered to the investing public. This is known as writing the scale. Most general obligation municipal bonds are issued with a serial maturity that matures over a period of years. The longer-term maturities carry higher yields than the bonds that mature earlier. When the syndicate has determined the prices and yields, they will submit the bid to the issuer, along with the required good faith deposit. All competitive underwritings are done on a firm commitment basis and the wining syndicate is required to purchase all of the bonds from the issuer, even if they can’t sell them to investors.