How Municipal Bonds are Sold in the Capital Markets
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Municipal bonds are investments purchased by all types of investors such as “mom and pop” retail, banks, money managers, investment advisors, hedge funds, insurance companies, and even governmental agencies. How certain investors get access to new municipal bond issuances is partly a function of how the bonds are sold.
There are Three Primary Sale Methodologies
Municipal bonds are typically sold under one of three sale methodologies: competitive, negotiated and private sales.
Under a competitive sale, a municipal advisor and bond counsel assist the issuer in publishing a ‘notice of intention to sell’ in a financial publication. This notice serves to alert broker-dealers and investors that a new municipal bond financing is coming to market on a fixed date and time. A ‘notice inviting proposals,’ which specifies the financing parameters such as the maturity schedule, redemption provisions and tax status, is then circulated to the municipal bond competitive bidding community. On the fixed date and time, broker-dealers will submit bids to purchase the municipal bond financing from the issuer. The municipal advisor and bond counsel will then verify that the bids comply with the financing parameters and the issuer will award the bonds to the lowest cost bid, which accounts for both the proposed interest rates and the underwriting fees. Once awarded, the winning underwriter will allot the bonds to their investors.
Under a negotiated sale, an issuer will retain a broker-dealer to serve as the underwriter for its municipal bond transaction. The underwriter will participate with the financing team in determining the financing parameters that will attract investors while meeting the issuer’s requirements. The underwriter pre-markets the municipal bond transaction to its investor clients, buys the bonds from the issuer and resells the bonds to investors on the scheduled sale date.
Under a private sale, a broker-dealer will serve as a placement agent and locate a sophisticated investor or bank to purchase the entire municipal bond transaction.
The Appropriate Sale Methodology is a Function of Many Variables
Generally speaking, a competitive sale can work well in a stable bond market for simple financing structures with strong credit ratings. Negotiated sales can work well in a volatile bond market for complex financings with weaker credit ratings. Private sales can work well for unique financing structures such as non-rated debt with a short-term repayment or non-standard redemption provisions. These descriptions are not meant to serve as strict guidelines. A competitive sale could do well in volatile market, a negotiated sale could do well with AAA-rated bonds and a private sale could do well with a standard financing.
The appropriate method of sale is very much case-by- case and a function of many variables.