Municipal market participants will soon have a new tool to help them in the process for awarding bids in a competitive auction.
The new bid award type, called TICPlus, will take call options into account in its calculations to find the lowest cost. And in the coming weeks, Ipreo will start offering TICPlus among its bid award types from which muni issuers and financial advisors can choose.
The new bid award type, in addition to capturing the time value of money and the differences in underwriting fees among the bidders, takes into account issuers' right to refund bonds at lower rates if the opportunity arises, said Andrew Kalotay, president of Andrew Kalotay Associates, a debt management advisory and fixed income technology firm. His group developed the idea and analytics for TICPlus and suggested it to Ipreo.
"The TIC calculation should be based on the sum of the proceeds and the refunding option value," he said.
Up until this point, issuers and FAs mostly have two options for how they award a competitive transaction. One is by what's called true interest cost, or TIC, which mostly revolves around a discounted cash-flow model. In mathematical terms, Kalotay writes, TIC is the discount rate that "equates the present value of the debt service generated by the issue to the appropriately defined net proceeds."
The second is the net interest cost, or NIC, which focuses more on the average coupon than the discounted cash flow. All told, low TIC represents about 99% of all competitive deals, said Anthony Leyden, director of municipal products at Ipreo, which acts as the clearing house for competitive deal bids.
In comparing two options, TIC is more indicative of the most suitable way to award a deal, said the head of the underwriting syndicate at a large bank who did not want to give his name or that of his firm. This entails looking at yield-to-maturity and determining the "all-in cost of borrowing and discounting it back," he said.
The idea of including the call option in the calculations is different, he added. But neither he, nor other underwriters The Bond Buyer interviewed on background had a strong reaction to TICPlus, or would comment on it without trying it first.
Still, the underwriter said, TICPlus would only be as good as the numbers — such as volatility and the forward curve, among others — the issuer or FA entered into it to calculate option value.
"So, you're making some assumptions that the financial advisor or the issuer is making the right assumptions, as far as the inputs, for valuing the option or not," he said. "Having not seen it, I'm not convinced it's great or horrible. I'm agnostic at this point, until we have a chance to take a look at it and to get a better sense from Ipreo what the value there is in this for the issuers."
Leyden also adopted an impartial stance. Ipreo should implement the new bid award within the next two months, he said.
"If it's something that might become available, we just want to make sure we're capable and the software will be able to handle it," he said.
In fact, the TICPlus calculation, Kalotay wrote, requires the issuer's option-less borrowing curve and interest-rate volatility. The issuer's spreads to a benchmark, such as those Municipal Market Advisors or Municipal Market Data provide, can be used to estimate the borrowing curve.
The call option calculation is important for issuers when they make funding or refunding decisions, Kalotay said. Because the winning bid in a competitive auction doesn't take optionality into account, he added, it typically has less optionality than some losing bids.
Looking over the winning bids in auctions, Kalotay noticed that the bonds proposed to be sold at or close to par do better than the bonds that have high coupons and a high degree of optionality. With all other variables being equal, he added, the higher the coupon, the greater the value of the call option.
TICPlus therefore would likely give issuers and FAs a more informed look at their options for the competitive bid, Kalotay said. "It doesn't mean that the high-coupon bonds would always win," he said, "but at least they get a fair shake."