Making a choice about whether to go to market on a competitive or negotiated basis is a decision that bears a great degree of weight. The primary elements of bringing a competitive vs. a negotiated transaction to market are as hotly debated as the nature/nurture conundrum is in psychology. The underpinnings for an orderly transaction are present in each case but the layers of complexity of the differences are ever present.
Many organizations have sponsored studies of the two approaches from the pricing and efficiency standpoint. The factors examined over the years have been revealing and meaningful. However, the findings from the studies have been far from conclusive.
For the issuer, paying a greater underwriting spread may result in a lower true interest cost than would be obtained otherwise.
Having been on all sides of this debate means I have had the opportunity to view the decision through many lenses. This most recent consideration has been prompted by a casual conversation with a not-to-be-disclosed underwriter. This person maintained that in the present market from the underwriting perspective, the underwriting spread has been greater on the competitive side. Years ago this statement would have amounted to municipal apostasy. The conviction was that negotiated transactions would bring greater underwriting spreads.
Indeed, in the last 10 years according to Bond Buyer data culled from the 2018 Yearbook, six years have had higher spreads for competitive transactions than for negotiated transactions. The word on the street is that the competitive underwriting spreads are higher on a year-to-date basis. The hard data should be out next week for the midyear.
In the last year, the competitive spread of $4.09 was significantly below the negotiated spread of $4.54. I would attribute the higher spread for negotiated last year to the record volume and to the relatively high degree of refunding that was conducted, especially in December when tax reform terminated advance refunding on Jan. 1, 2018.
What is different now than years ago is that more issuers have a municipal advisor to assist them with the decision tree. The municipal advisor has the fiduciary duty to their client first and they are usually compensated on a contractual basis; so, they are indifferent and objective about the choice.
Though there are many perils in trying to boil the decision down to its elements, in the end, the financing team recommends a path that is best for the issuer to tap the market.
For a frequent issuer with a stable rating, up-to-date disclosure and a straightforward structure, a competitive transaction may be the first choice. One factor that could change this premise is the size of the transaction. The competitive market routinely places deals that range from small transactions to issues of hundreds of millions of dollars. Once the transaction attains the $1B mark, there is more to consider. If the issue is to be originated in a specialty state, one would expect a lot of built-in demand from retail. The state of California often sells GOs in excess of $1B in the competitive market with ease. Of course, the state also sells many transactions on a negotiated basis. The fact that appetite for California paper is so strong that rates through the AAA scale also provide a good environment for a competitive sale with the built-in retail demand. Florida is another state that often taps the competitive market for its origination from multiple issuers at the state level with large par amounts.
Clearly, the supply and demand in the individual state matters greatly in the decision making. One tends to discuss the deal in terms of whether it is a “national” deal or a “state” deal. A national transaction demands a great deal more effort to distribute. It probably means there are not as many natural buyers for the transaction in that particular state. Texas paper is usually national in scope when the transaction is large and from one of the major credits in the state. This status is driven in part due to the lack of an income tax. Nevada is similar in this regard. However, demographics and the wealth of the buyer base are also factors.
One also talks about whether the transaction is an “institutional” transaction. This label usually speaks to the complexity of the credit or the complexity of the structure of the bonds. In quite a few cases, both factors apply. Knowing where the buyers will come from for a “national” transaction requires an appreciation of art and science and a lot of empirical caseload evidence. The skill of the underwriters on the desk is critical in this regard. They have faced all kinds of market conditions and think deeply about what the best approach is for the transaction.
This level of contemplation is typically available and on demand in the case of negotiated underwriting. In difficult market environments, this option is often the best choice. I only have to think of the difficulties all issuers experienced in the fall of 2008. Even issuers with Aa/AA ratings or higher had encountered challenges in completing their transactions. Underwriting expertise in a negotiated setting made a very real and measurable difference at that time.
Another rationale to go to market on a negotiated basis is that entirely new credits are quite challenging to launch. The buy side must have enough time to dissect the credit and then carefully parse where the credit spread should be on the continuum. The underwriters need to parry with relevant points of the credit and where they think the relative value should be. This consideration is difficult to achieve on a competitive basis but it is not totally out of the question. There is also the consideration of the need for a road show or webinar that must be carefully prepared.
I know there are strident and staunch supporters in each camp. I do not know that there would be any article or study that would settle the score. The debate will be ongoing for time immemorial. I would just propose that we all remain open to the virtues of the two approaches. They have coexisted for a very long time.
Underwriting spread is a very important factor but there are many more to be considered in tandem.
There is no need to settle the competitive versus negotiated debate.
