Despite concerns that retail investors may not always be getting a fair shake when they place an order to buy municipal bonds during a new-issue underwriting, the so-called retail order period has a long track record and will continue to be vital to the market, municipal experts and underwriters said.
Retail order periods, or ROPs, were created to give mom-and-pop investors some muscle in the battle for bond allocations by giving their orders priority consideration a day or two — or sometimes three — before the official pricing for institutions.
Retail investors, long the primary buyers of tax-free municipal bonds, have become even more critical to the market in recent years and issuers have stepped up efforts to woo them.
“Retail order periods are still very popular in the municipal world — especially for larger deals. It’s very important for municipalities to get access to their bonds for their constituents,” said John Bagley, president of BondDesk Trading, who spent 25 years as manager of muni trading and sales at UBS Financial in New York City.
“A successful retail-order period can help drive your pricing,” he explained. “If the deal is subscribed for during the retail order period there are fewer bonds to sell during the institutional period. It accomplishes a way of building a book of business before going into the institutional period,” he added.
A managing director at a large Wall Street firm agreed, saying, “It gives issuers transparency as to what the market may pay for their bonds.”
He noted that ROPs as we know them today came into existence nearly 20 years ago when interest rates were significantly higher “and individuals were having a hard time getting access to bonds.”
Prior to ROPs, he said, broker-dealers placing orders on behalf of retail clients were often times given allotments that were much less than they requested due to overwhelming demand from institutional investors.
“Retail order periods came to be because retail was not as sensitive to price [as institutions], and they were willing to pay more to get bonds,” he added.
Over the years, they have virtually become standard procedure for many large, high-quality issuers — especially those bringing large deals, or high-tax states with investors seeking exemption from taxes on interest.
Alan Anders, director of New York City’s Office of Management and Budget, said the city was one of the first to utilize ROPs regularly in its financings beginning in 1994, and it continues to garner strong retail demand during the preliminary pricings for its general obligation debt and other city-related financing entities.
He noted that orders from mom-and-pop investors typically account for 40% of a New York City GO sale during the order period.
According to rules established by the Municipal Securities Rulemaking Board, issuers set the terms and conditions for retail order periods.
Generally, many take place the day before the official pricing, though there are some variations. Some issuers opt to give retail investors priority just hours before a deal is to be priced for institutions, while others offer bonds up to three days before, sources explained. Issuers can also opt to give in-state retail investors priority over national retail.
On Wednesday, Morgan Stanley will likely give New York retail investors priority over national retail accounts when it prices the largest deal of the week — a $1 billion sale of revenue refunding bonds from New York State’s Metropolitan Transportation Authority, according to a source at the firm. The deal, which is expected to be priced for institutions on Thursday, is rated A2 by Moody’s Investors Service and A by Standard & Poor’s and Fitch Ratings.
Typically, the lead underwriter releases a preliminary pricing scale for retail investors. Those prices may or may not be bumped up or down at the final pricing, depending on institutional demand, the tone of the market and interest rates at the final pricing.
For instance, last week, Ramirez & Co. held a one-day ROP for a $234.7 million lease revenue deal from the Dormitory Authority of the State of New York for the State University of New York system. The issue ended up also being priced for institutions — and repriced lower in yield — later that day because of heavy demand.
Issuers can benefit from such supply-demand imbalances, experts said, as was the case in the SUNY deal where yields at the final repricing were cut, ranging from two basis points to 0.037% in 2014 to three basis points to 3.37% in 2042. “Issuers want institutions to lead retail to the higher price” the managing director said.
ROPs “continue to be a good baseline and good lead in as a place-setting for the institutional order period,” Anders said.
Typically, issuers present all or most of the maturities during the preliminary pricing, but sometimes they designate certain maturities for retail and preserve others, such as those with unique structures or lower credit quality, for institutions, sources said.
Broward County, Fla., plans to reserve certain maturities for retail from its $636 million revenue bond sale for Fort Lauderdale-Hollywood International Airport, scheduled for pricing by Citi on Wednesday. A 20-year serial structure with terms in 2037 and 2042 is planned, but a Citi source on Monday said the firm was still deciding on retail priorities.
Back in August, JPMorgan offered most of a $523 million personal income-tax revenue bond sale from the New York State Thruway Authority to individual investors, except for those in 2013, 2014, and between 2024 and 2031. The deal, rated AAA by Standard & Poor’s and AA by Fitch, was unchanged from the order period, with yields ranging from 0.50% in 2015 to 3% in 2032.
Besides deciding how and when to market their deals, issuers also choose what orders classify as retail.
Not everyone likes how issuers decipher retail orders, or how they are prioritized, and that has long been the cause of debate among market participants.
“One thing that continues to evolve is the definition of a retail order period,” said BondDesk’s Bagley. “First it was only individuals and then money managers as a proxy for retail orders.”
A debate continues over whether, for instance, separately managed accounts that “behave” institutionally should be given preference over mutual funds — if and when the SMA is managing money for individuals, according to the New York managing director.
He said a growing number of retail investors are accessing the market through managed accounts, such as SMAs, following a spate of market volatility in recent years.
That is in stark contrast from just five years ago when half of the new-issue muni market was insured and “there was no fear of credit and default risk and investors were comfortable,” he explained. “Now, there is very little insurance and a heightened awareness of big states having problems. A significant amount of money from individuals is going into these managed platforms.”
Meanwhile, experts said ROPs also can be challenging in volatile markets, and when doing a refunding bond issue.
“With a refunding certain things have to fall into place and you have to get the deal done at a certain price to save money for the issuer,” Bagley explained. “You do not want to lose a deal because of the time its takes to complete a retail order period.”
In order to protect issuers and investors, the MSRB is seeking to crack down on dealers who bend the rules when it comes to ROPs. The agency has had growing concerns in the past two years that dealers have showed a disregard for certain terms and conditions required by issuers, ranging from unfair pricing to the failure of syndicate managers to disseminate timely information to all dealers.
The board plans to release feedback within the next month from market participants about proposed amendments it seeks to make to its rules regarding the use of ROPs, according to an MSRB spokesperson.
Anders said issuers need to be consistent with the board’s guidelines, especially as they relate to disclosing limitations and conditions to the underwriting syndicate. “Our rules are set out in the underwriting wire and it is well-known in the marketplace,” he said.
Anders said New York City determines its retail customers by order size. For the city, an order placed for $1 million or less is considered to be a “retail order,” he said. “Over that, they need to come to the book-runner and explain what the order is. It could be an accumulation of a lot of smaller orders.”.
Despite kinks in the system, experts agree that ROPs will continue to be a mainstay of the muni market.
“There’s a continued sensitivity to make sure retail has access to bonds, and a heightened awareness to make sure orders are being placed and bonds are going away [to retail], and I don’t see that trend changing anytime soon,” the New York managing director said.