Choosing the Method of Sale for Your Bond Issuance
A breakdown of the most common ways to sell your bonds.
By Bill Evans
Head of Underwriting
When it comes to financing an infrastructure project or refinancing existing debt, state and local governments as well as other tax-exempt issuers have multiple options for selling their bonds. Typically, the rule of thumb for selling bonds is to borrow at the lowest cost possible while considering the impact of your issuance on taxpayers and/or ratepayers. Because of this, different methods of sale may offer you a more advantageous borrowing cost.
Selecting an Underwriter
If you’re using a municipal advisor to represent you in your debt offering, their advice can go a long way in helping you select an underwriter. Since they are your fiduciary— advising you on the structure, size, and rating process of your issuance—they have a deeper knowledge of your overall financial condition and financing objectives. Issuers with a debt management team on staff may also have the market and sector knowledge to make a beneficial selection. However, if you do not have sufficient in-house support, the Government Finance Officers Association is a good source of information.
If you choose to engage a municipal advisor, keep in mind they have a fiduciary duty to look out for your best interests. Underwriters, on the other hand, have a duty to purchase your issue at a fair and reasonable price. However, they also have the same duty to their investors.
While this may seem like a drawback, there are controls in place to protect you. The Municipal Security Rulemaking Board (MSRB), which regulates both municipal advisors and underwriters, issued and regularly amends Rule G-17. Known as the “fair dealing” rule, G-17 sets forth requirements underwriters must follow when purchasing your bonds—up to and including complete transparency in the underwriter selection process.
That being said, there are two overall factors that stand to determine the method of sale for your issuance:
The state and/or local charter mandates a competitive bid for all bond sales or the issuer has a transaction with a rating, size, market, and/or structure that could benefit from a competitive sale.
You are seeking underwriters with specific qualities in addition to getting the lowest borrowing cost possible.
In the first instance, you’re required by charter or other market considerations to enter into a competitive bidding process to select your underwriter. These charters are put in place to protect the short- and long-term interests of taxpayers and/or ratepayers in the affected community.
In the second instance, you’re able to choose the method of sale for your issuance, and you are looking to engage an underwriter with particular characteristics (specializing in a specific investor base, a national vs. local distribution network, etc.) who can also provide the best borrowing cost.
In any case, it’s important to have a strong understanding of each method of sale available to you in order to make an informed decision. The following are the most common methods of sale for municipal securities issuances.
Competitive Bond Sale
Many market participants believe that competitive bond sales are the only way to assure the lowest interest rates possible. This option is also a common choice for issuers with strong credit ratings who are seeking to issue well-sized bonds—both of which tend to drive the cost down in the bidding process.
With this method, the issuer—along with a municipal advisor, if one has been engaged—prepares a Preliminary Official Statement (POS) that covers all the pertinent information regarding the issuance. Then they prepare legal documents and a Notice of Sale (NOS) that provides information regarding the bidding process. Prior to distributing the POS and NOS, the issuer undergoes the rating process. Once complete, they advertise the documents to prospective underwriters, who then bid based on their review of the documents, credit rating, and investor appetite. Any broker-dealer or bank may bid on the bonds at the designated date and time, and the issuer awards the bonds to the bidder offering the lowest true interest cost or net interest cost.
While underwriting firms may attempt to secure the best interest rates for the issuer, different firms have different perceptions of the market and cater to various investor clients. This is evidenced by the fact that there are seldom two identical bids submitted in a competitive sale.
Negotiated Bond Sale
An issuer may choose to enter a negotiated bond sale if:
The bonds are rated on the lower end of investment grade
The issue amount is unusually large
The issuer does not have an established history in the municipal market
The issue has unusual financing terms or an uncommon structure
Volatile markets make it difficult to secure a low interest rate
In all of these scenarios, a negotiated sale provides the prospective underwriter with time and space to secure investors, making it more appealing for them to purchase the bonds.
In a negotiated sale, an issuer may release a Request for Proposals (RFP) or Request for Qualifications (RFQ) with the assistance of their municipal advisor or bond counsel. After reviewing the submitted proposals, the issuer will select an underwriter (or team of underwriters) to purchase the bonds. This process gives the underwriter enough time to begin pre-marketing the bonds to prospective investors and determine interest before establishing final bond pricing. In addition, pricing isn’t agreed upon until the time of the sale, which lets the issuer adjust bond features (maturities, coupons, etc.) as needed.
Because this method is ultimately an ongoing negotiation between an issuer and an underwriter, it’s important for both the issuer and underwriter to maintain a high level of transparency.
Private Placement/Direct Purchase
Issuers seeking to issue debt typically with a lifespan of 10-20 years or less might consider selling their bonds directly to a qualified investor through private placement or direct purchase based on the type of transaction, the cost of issuance, and the timing.
With this method, issuers work with their municipal advisor and/or a placement agent to draft a term sheet (note: a municipal advisor cannot provide a list of prospective investors). The term sheet is then circulated to pre-selected banks and other sophisticated investors. The issuer, municipal advisor, and/or placement agent review the proposals and select the bank or investor they feel best meets the issuer’s needs and prepare the applicable authorizing/loan documents to close the sale.
Using private placement or direct purchase to sell your bonds can be a beneficial option. First, in a private placement, issuers are not required to draft official statements—only a loan document. Second, the cost of issuance is generally less expensive than selling in the primary bond market. Third, the process is commonly less time intensive. Finally, banks and other sophisticated investors can be more flexible on the various bond features.
The MSRB recommends that issuers who choose this method should disclose the sale on the Electronic Municipal Market Access, or EMMA, website to remain transparent with the municipal market community.
Choosing the Right Method of Sale for Your Issuance
To sum up, the primary objective in selecting the method of sale is to choose an option that either offers the lowest borrowing costs or meets the special criteria of your issuance. In both cases, you are trying to get the best interest rate for the benefit of your taxpayers and/or ratepayers. As a fiduciary, your municipal advisor must provide advice that meets the best interests of your organization, including type of sale, bond structure, and underwriter selection. Furthermore, the MSRB’s Rule G-17 obligates your underwriter to disclose any information or conflicts of interest that could affect the sale of your bonds.
To learn more about selecting an underwriter or the various methods of sale available to you, contact HilltopSecurities at 214.953.4156 or email our Public Finance team today.
This communication is intended for issuers for educational and informational purposes only and does not constitute legal or investment advice, nor is it an offer or a solicitation of an offer to buy or sell any investment or other specific product or service. Financial transactions may be dependent upon many factors such as, but not limited to, interest rate trends, tax rates, supply, and change in laws, rules and regulations, as well as changes in credit quality and rating agency considerations. The effect of such changes in such assumptions may be material and could affect the projected results. Any outcome or result HilltopSecurities, or any of its employees, may have achieved on behalf of our clients in previous matters does not necessarily indicate similar results can be obtained in the future for current or potential clients. HilltopSecurities makes no claim the use of this communication will assure a successful outcome. This communication is intended for institutional use only. For additional information, comments or questions, please contact Hilltop Securities Inc.