The Underwriting Process
Municipal bonds typically are brought to market through an underwriting process. As part of this process, one or more municipal securities dealers – also known as underwriters – purchase newly issued securities from the issuer and sell the securities to investors.
Assembling the Financing Team
Once a state or local government decides to finance a capital project by issuing bonds, it would hire a financing team to finalize the financing plan, develop offering documents, prepare for any rating agency and investor presentations, market the bond offering to investors, price the bonds and close the transaction. Generally, the bond offering process is a coordinated effort among various professionals, such as municipal advisors, bond counsel, underwriters, underwriter’s counsel, rating agencies, trustees and others. Read more about the roles and responsibilities of the financing team in an initial municipal bond offering.
Pricing the Security
The initial offering price is the price at which a new issue of municipal securities is offered to the public at the time of original issuance. In some cases, the initial offering price is set at a premium or discount to par value. Municipal bonds normally are sold to investors based on the yield of the transaction -- an expression of annual rate of return on an investment -- and takes into account any premium or discount from the par value. For example, a transaction priced at 100% of par value of a bond will have a yield equal to the stated interest rate on the bond often referred to as the coupon, while a transaction priced at a discount to par value will have a yield higher than the coupon.
The specific yields at which new issues are sold reflect a number of factors relating to the market value of the securities being offered. These include characteristics of the specific securities being offered – type of security, terms and features and credit quality, for example – as well as the general interest rate environment and credit market conditions.
The gross underwriting spread, which represents expenses and compensation to the underwriter distributing new issue securities to investors, is the difference between the price paid by investors and the amount paid by an underwriter to the issuer. For example, if the issuer issues $10,000,000 in bonds for sale to investors at an initial offering price of par (face value), and the underwriting spread is 1%, the issuer would receive $9,900,000. The exact amount received by an underwriter depends on whether the initial offering price was obtained for all of the securities in the issue.