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Since 1895. Member SIPC and NYSE.
The Basics of Municipal Bond Underwriting
Presented By: Darci Doneff
Managing Director, Municipal Trading and Underwriting
Wednesday, January 10th, 2007
The Municipal Market Defined
Definition of the municipal securities market
• Municipal securities are debt obligations issued by states, cities, counties, and other governmental entities to raise money to build schools, highways, hospitals, and sewer systems, as well as many other projects for the public good.
• Municipal Securities are the most important way the U.S. state and local governments borrow money to finance their capital investment and cash flow needs.
Characteristics of Municipal Bonds
Municipal Bonds Carry Unique Characteristics
• The most important distinguishing characteristic of the municipal securities market is the exemption of interest from federal income taxes
• Municipal issuers can therefore borrow at significantly lower interest rates than other debt markets
• There are currently in excess of $2 trillion in outstanding municipal debt
• There are more than 70,000 issuers with over 3 million CUSIPS
Municipal Market ~ Underwriting Volume
2006 Statistics
$390 Billion
Fixed Rate 84%, $329 Billion
Variable Rate 16%, $61 Billion
Negotiated 75%, $294 Billion
Competitive 25%, $96 Billion
A-1
Municipal Market ~ Underwriting Participants
Primary Market Issuers Financial Advisors Bankers Underwriters Sales Staff Investors
Secondary Market Traders Investors
A-2
Municipal Market ~ Participants continued…
Issuers State & Local Governments Special Purpose ~ Authorities, Districts, and Non-Profits
Underwriters and Bankers Senior Manager
May assist issuer and FA with financing plan. Communicates with issuer, FA, and co-managers. Manages the bond sale process.
Co-Managers Adds marketing capability and expands investor base through
local presence, middle market capabilities, or special niche investors.
Supports the sale by committing capital to buy/sell bonds.
Sales Staff Institutional Direct & Pooled Retail
A-3
Municipal Market ~ Investors
Tier 1 Top 100 Accounts Large Arbitrage & Hedge Funds, Bond Funds,
Corporations, Insurance Companies, Money Managers, Mutual Funds, Large Banks
Tier 2 Middle Markets Mid-size Banks, Corporations, Funds, Insurance
Companies, Money Managers, Trusts
Tier 3 Direct Retail Pooled Retail
A-4
Types of Municipal Underwriting
Competitive @ 25% of Market Most General Obligation, AAA Insured and other
straight forward structures. Stable market conditions.
Negotiated @ 75% of Market Relatively complicated transactions Transactions sensitive to small swings in interest
rates. Issuer/Transaction lacks strong investor demand. Volatile bond market.
B-1
Competitive Underwriting Defined
Competitive Underwriting
• Process whereby an underwriter submits a sealed bid to the issuer via electronic, fax or hand delivery
• Issuer selects the underwriter bidding the best (highest) price and the lowest interest cost
• Depending on the size, credit quality and current market conditions an issuer can expect to receive on average 5 separate bids
Competitive Underwriting Process
Issuer Identifies a Capital Need:
Ex. City of Minneapolis
Road Improvements
Determine Sale Date & Time
Closing:
Distribute proceeds to issuer and road construction begins
Issuer Accepts Bids & Awards
Based on Low Interest Cost
Locate Buyers Dealer Takes Issue
Into Inventory
Negotiated Underwriting Defined
Negotiated Underwriting
• Process whereby both the purchase price and the offering price for a new issue are negotiated between the issuer and the underwriter
• The underwriter pays the issuer a purchase price and the public the offering price the difference represents the spread the issuer pays
• Underwriters selected to negotiate a new issue generally must first enter into a request for proposal (RFP) process
Negotiated Underwriting Process
Issuer Identifies a Capital Need:
Ex. Hennepin County decides
to build a new Twins Stadium
RFP Process
Interview Bankers
Closing:
Distribute proceeds to issuer and begin construction
Marketing
Locate Buyers Pricing
Competitive vs. Negotiated
CompetitiveNegotiated
Date & Time Set FlexiblePricing Parameters Set FlexibleCall Features Set FlexibleUnderwriting Spread ?? SetMarketing Time Frame ½ day 3 weeksCoupon Bifurcation No YesRetail Priority ?? Yes
Some considerations:
B-2
Deal Economics of Municipal Underwriting
Underwriting Spread
Management Fee $ per $1,000 of bonds issued. Fees to structure the bond issue. If FA structured the transaction, Management Fee is often $0.
Takedown $ per $1,000 of bonds issued. Bond sale “commission.”
Clearance Related Expenses Fixed costs to issue bonds (MSRB, wire fees, etc…)
Out-of-Pocket Expenses Variable costs to issue bonds (travel, copying, etc…) Underwriter’s Counsel
E-3
How Are Prices Set In The New Issue Market?
Municipal new issues are bought and sold on the basis of:
• Credit quality
• Maturity
• Liquidity
• Yield
Yield is the most important element for an issuer and an investor in evaluating the merits of the transaction
F-1
New Issue Pricing Factors
A lot of factors must be taken into consideration for each new issue that is priced.
Factors include:
• What is the prevailing level of interest rates?• What is the supply and demand for the issue?• Creditworthiness of the issuer?• Is the issuer well known?• What is the maturity?• Will it be difficult to find investors for the issue?
Negotiated New Issue Pricing ~ Scheduling
How do we link the schedule with investor interest? Monitor Volume
Forward Supply Time of Year
Size Makes a Difference Large issues get attention of all investors. Small issues somewhat limited to middle market investors,
small money managers, and retail.
Name/Rating/Credit Easy to sell – G.O.’s and bonds related to an essential purpose. More difficult – health care, hospitality, housing, “dirt deals.”
Monitor Economic Data
Monitor Current Events
C-1
Negotiated New Issue Pricing ~ Marketing
How do we match the issue to the right investors?
Structure
Size – some investors have restrictions as to minimize size and population
Underlying Ratings – split ratings can hurt marketability
Credit Enhancement/Insurance
Issuer Name
Call Features
C-2
Pricing ~ Marketing continued…
How do we tailor marketing to a specific issue?
Unique marketing plan for each issue.
Wherever possible, underwriting and sales staff are made aware of the issue at least one month before pricing.
Internal Sales Bulletins
Informational conference calls including Bankers, Underwriters, and Sales Staff to discuss financing plan.
Issue placed on national calendar for maximum exposure.
C-3
Pricing ~ Final Preparations
Two Weeks Prior to Pricing Distribute Preliminary Official Statement (POS) to
potential investors.
Respond to questions from potential investors and other market participants as to market timing, structure, etc.
One Week Prior to Pricing Confirm pricing date with banker and issuer.
Due Diligence Call with issuer, FA, banker, and attorneys.
Call with underwriting team to outline marketing plan
Monitor competing issues in the market.
C-4
Pricing ~ Final Preparations continued….
Day Prior to Pricing Gather price thoughts from co-managers (when
syndicated)
Confirm structure with issuer and banker based on market conditions
Pre-Pricing Call with issuer and banker
Communicate price ideas with investors through sales force
Continue receiving feedback from investors
Underwriting and sales staff finalize plan for the next day’s pricing
C-5
Pricing ~ Day of Pricing
Finalize structure for the price release.
Pricing Call – The Issuer gives the green light to proceed with the pricing
Send out pricing wire to market participants with details of pricing
Run an order period Generally, minimum 1 hour/maximum 2 hours Monitor order flow. Continuously communicate with Sales Staff. Conference call with Issuer, FA, and Banker. Consider changes to price/structure if needed.
C-6
Pricing ~ Day of Pricing continued…
Re-price, if necessary.
Conference call with Issuer and Banker Negotiate the final price. Provide commitment to underwrite. Receive verbal award from Issuer.
After Pricing Banker forwards Final Pricing Summary to Underwriting
Staff for review. Issuer and Senior Managing Underwriter sign the Bond
Purchase Agreement. Senior Managing Underwriter allocates bonds to investors. Issue is “booked” and trades are processed. Secondary trading may begin, usually the day after pricing.
C-7
Pricing ~ Summary
C-9
1 Week Prior to Pricing
2 Weeks Prior to Pricing
Marketing
Scheduling
Pre-Pricing
Pricing
Rep
rici
ng
BPAClosing
Piper Jaffray Municipal Underwriting Overview
Piper Jaffray is a leader in New Issue Underwriting
2006 Rankings:
• Ranked 12th in competitive and negotiated long term issues combined with a par amount $6.6 Billion
• Ranked 4th in number of senior managed long term issues with 452
• Ranked 13th in negotiated long term issues with a par amount of $5.2 Billion and 4th in number of issues with 311
• Ranked 11th in competitive long term issues with a par amount of $1.4 Billion and 6th in number of issues with 141
Including short term issues Piper Jaffray senior managed a par amount of $7.7 billion new issues in 2006. We also completed a substantial volume of co-managed underwritings, financial advisory and loan placements
Municipal Underwriting
Q&A
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