How underwriters are complying with issue price rules
WASHINGTON – Many underwriters are opting to “hold the offering price” for five business days to comply with the new issue price rules, even if they are not doing an advance refunding or other transaction where they have to know the issue price on the sale date, according to market participants.
Underwriters find the five-day hold option attractive because they can be certain of the price of the bonds on the sale date and can limit the tracking and reporting of prices, market sources said.
Some issuers are not sure whether they are paying more for the five-day holds on prices, although several sources said they are not.
This issue price rules took effect on June 7. Most issuers, municipal advisors and dealer sources say that more time is needed to fully assess the market impacts of the rules.
Under the new rules, the issue price is the price at which the first 10% of a maturity of bonds is sold to the public. If 10% of a maturity is not sold at the sale date, issuers and dealers can use the initial offering price (IOP) as the issue price as long as the underwriters hold it for five business days after the sale date.
Dealer groups have put issuers on notice that, by holding the IOP for five days, an underwriter is taking a risk that prices won’t move against it and may, accordingly, charge the issuer for that risk.
For competitive sales, issuers and underwriters can treat the reasonably expected IOP of the bonds as the issue price as long as the issuer receives at least three bids for the bonds and meets certain other conditions. If three bids are not received, underwriters can still opt to hold the price for five days or wait until 10% of each maturity is sold. In some cases they can opt out of the transaction.
Lawyers, issuers and some dealer professionals said compliance with the rules has worked fairly well and that chaos has not resulted as some had forecast.
“I think it’s generally working itself out,” said Tom Vander Molen, a lawyer at Dorsey & Whitney in Minneapolis and chair of the National Association of Bond Lawyers’ tax law committee.
“But one thing that I had predicted that some people had doubted, is that most underwriters are often perfectly willing to hold the offering price, and some of them actually prefer to do so, rather than undertake the reporting obligations that would otherwise apply,” said Vander Molen. “A lot of them say, ‘We’d just as soon hold the offering price and be done with it.’”
“Some dealers don’t want to have to worry about keeping track of prices after the deal sells for more than five days and reporting back to the issuers,” said a dealer source who did not want to be named. “They think that’s too much paperwork, particularly if they have a lot of deals going on, so they just hold the price for five days and then be done with it.”
“It really has been a non-controversial process,” said Darren McHugh, a lawyer at Stradling Yocca Carlson & Rauth in Denver.
“But I’ve been surprised at the willingness or insistence of certain underwriters to want to hold the price for five days even in non-issue price sensitive transactions,” he said, adding, “It gives us the ability to move forward with finalizing transaction documents.”
Issue price-sensitive transactions include advance refundings, where knowing the issue price on the sale date is important so issuers and underwriters know the bond yield, and consequently what the investment yield has to be so they don’t violate yield restriction requirements.
Other issue price-sensitive transactions include bank-qualified bonds, bonds with reserve funds, and some private activity bonds, where the bond yield is important for determining size or compliance with tax law restrictions, lawyers said.
“I think everybody’s gotten comfortable with [hold the offering price for five days],” said Todd Fraizer, managing director and head of PFM’s pricing group. “That seems to be the default.”
David Erdman, Wisconsin’s capital finance director, said his state did a negotiated deal the week after the issue price rules took effect and the underwriter initially wanted to hold the offering price. Erdman said he wanted the prices to be based on actual results. Ultimately, he and the underwriter agreed that the market was strong enough that they would sell at least 10% of each maturity right away and not have to worry about holding the price.
“I’m still concerned that compliance with the issue price rules is going to end up costing us,” Erdman said.
He said he’s heard that many underwriters want to “hold the offering price” to comply with the rules. “I’ve had underwriters tell me that it’s no cost to the issuer.”
“At the end of the day, this for the most part has been a non-issue and we haven’t seen any pricing impact,” said Fraizer.
But Erdman said that might not be the case in a volatile market. “Let’s talk to the underwriters after we’ve had some markets like we saw in December or November where holding the market for five days starts to cost some pennies,” he said.
“The concern that I think the issuer community has is any time you throw out there that the underwriters have to hold the price for five days, there’s going to be a risk element and that’s going to be reflected in some widening spreads,” which means a higher cost of capital for the issuers, Erdman said.
Asked if issuers are paying more, Eric Johansen, debt manager for Portland, Ore., said “Intuitively I would think that would be the case,” but added that it’s hard to tell.
Erdman agreed. “Unless an issuer has a long history of issuing and they can compare current spreads to historic spreads …. But there are so many other factors on spreads. It’s hard to point to issue price compliance as the reason for a widening spread.”
But Fraizer said issuers have not had to pay higher prices. “It really has been a non-event in terms of pricing.”
“I don’t have any knowledge that the banks are charging anything different on hold the offering price,” said McHugh. But he added that, being on the legal side of transactions, he’s not in the best position to gauge the pricing.
Another concern, Erdman said, is that lead underwriters complying with the issue price rules may want to sell any unsold bonds, when the 10% amount hasn’t been met, themselves rather than hand them over to syndicate members. As a result the distribution network for the bonds might be more limited.
“I think it’s still a little too early to come to conclusions,” Erdman said, adding his comments are “reflections, observations, concerns.”
Some lawyers report that they are seeing a number of pre-engagement conference calls take place for negotiated deals to determine if the underwriter plans to hold the price and, if it does not, how compliance with the issue price rules will be accomplished.
Another issue that has come up is related and affiliated parties to members of the underwriting syndicate. The issue price is the first 10% of each maturity sold to the public and the definition of the public excludes underwriters and related parties.
In some cases a syndicate member may have a bank affiliate that puts in an order for one maturity of the bonds. Also, there may be a sealed bid for a maturity – generally bids for money market eligible bonds with maturities of 13 months or less are sealed – and a syndicate member wins that bid. Transaction participants are trying to determine if those sales can be used to determine the issue price for those maturities. Questions arise as to whether the underwriter actually sold the bonds to the public, and if the bonds weren't sold to the public, whether the-hold-the-price rule would apply.
Some issuers are reportedly trying to get issue price certificates from every member of a syndicate, one lawyer said, adding, “If it’s a big syndicate, that’s a lot of firms.”
But transaction participants said they are working through most of these issues.
Everyone expects, as they resolve these issues, that the model bond transaction documents released by that the Securities Industry and Financial Markets Association and the National Association of Bond Lawyers for issue price compliance will have to be tweaked, sources said.
It was difficult obtaining information on competitively-sold bonds. Most sources said they are unaware of how competitive deals were complying with the issue price rules.
PFM did some research on the market for competitive transactions in 2016 and found that only about 894 or 13.5% of those deals had less than three bids.
The average par amount of those was about $3.5 million. “The vast majority was very small,” said Fraizer, adding they many of them were bank-qualified bond anticipation notes and some school district bonds.
Regarding the 13.5% of competitive deals that received less than three bids, 42% to 43% of those were in the New York-New Jersey area, he said.