ST. LOUIS -- If you are a state housing director, chances are good that you will hear from Spencer Burke sooner or later.
Whether it is by letter, over the telephone, or in person, Mr. Burke, the head of investment banking at Edward D. Jones & Co. in St. Louis, is pitching a simple gospel to states: His firm's retail customers badly want your bonds and are willing to buy them at a lower cost than institutional investors.
"We've been telling our story to five or six states," said Mr. Burke, a bond lawyer-turned-investment banker. "If you go to most states, they tell you they don't have [retail] demand. They're wrong. We tell them they ought to try and exploit that unmet demand."
Mr. Burke contends that state housing agencies can save from five to 30 basis points in interest costs on billions of dollars of single-family housing bonds by marketing their bonds to the retail market.
A few agencies are pursuing such a strategy. Since 1990, for example, the Missouri Housing Development Commission has sold about $400 million of bonds through a syndicate senior managed by four regional firms -- a job previously held by a Wall Street firm.
But many state housing officials are far from convinced that developing retail interest is worth the effort.
"We like to sell to Georgia investors," said Terry Duvernay, executive director of the Georgia Residential Finance Authority. "But I'm not sure [marketing bonds directly to them] makes a lot of difference."
Understandably, national brokerages and their institutional clients have shown little enthusiasm for Mr. Burke's idea.
Diversity of Views
Opinion on whether retail investors should be courted are as diverse as the nation's 50 state housing agencies. So far, only a few agencies have targeted the individual investor market that has been growing in the wake of the Tax Reform Act of 1986.
Since 1987, the Pennsylvania Housing Finance Authority has sold some $800 million in debt under a program to market bonds to retail investors, particularly those in the state. Brian Hudson, assistant executive director for finance and administration, estimates that the efforts by regional firms have resulted in savings of five to 10 basis points.
Should underwriters do the extra work needed to get those savings? "I think it's worth the effort," Mr. Hudson said.
For the underwriters of a $51 million issue for the New Hampshire Finance Authority, marketing their issue to retail buyers resulted in an estimated 20-basis-point savings.
"There was no institutional interest at all, so they had to sell it this way," said Clif Fenton, national manager of structured finance at John Nuveen & Co. in Chicago, a co-manager on the deal. "It was about 20 basis points through the institutional rates."
Many state housing officials, however, say it is difficult to quantity the benefits of targeting certain bonds to the retail market.
Earlier this year, for example, the Michigan Housing Development Authority sold a $29 million issue using only regional firms. For years, the agency had sold to institutional buyers through Wall Street firms.
"We had mixed feelings about just doing it for Michigan people," said George Fox, director of finance at the authority. "We were happy with the results, but I can't tell you what we would have paid otherwise."
Most officials, however, agree that it is good politics to sell bonds in-state. It also could be good economics to shift underwriting profits from Wall Street to local firms, they say.
In Texas, the state's Department of Housing and Community Affairs is studying the possibility of targeting more bonds toward retail investors and giving underwriting contracts to regional firms.
"I think that eventually it could drive down our [interest] costs," said Ginger Brown, interim director of housing at the agency. She also cited a further benefit, adding, "It's the idea of doing what you can to boost the local economy."
The decision in Missouri to switch to regional firms in 1990 was a boon to the firms -- A.G. Edwards & Sons, Edward D. Jones & Co., and Stifel, Nicolaus & Co. of St. Louis, and George K. Baum & Co. in Kansas City -- bit a loss for Wall Street.
Richard Grose, executive director of the Missouri Housing Development Commission, said the policy meant the elimination of PaineWebber Inc. as senior manager, even though officials were pleased with its performance.
Since the change, he said, "We have been satisfied with it.... We feel we have met or beaten the market in every case."
Martin Crowe, chairman of Smith, Moore & Co. in St. Louis, the agency's financial adviser, said the goal has been to give Missouri investors the first shot at buying the bonds.
In fact, when the commission sold a $140 million issue last spring, he estimates that up to 70% of the issue was sold to in-state buyers. "I think it has worked," Mr. Crowe said.
That pleases Robert Crancer, one of seven commissioners who oversee the agency. He said the idea was met with indifference at first but has evolved into a successful program.
"To me, it was just criminal to see those bonds flipped out of state. This gives Missouri investors the first shot," Mr.Crancer said. "I used to get calls asking why can't we purchase these bonds. I don't get those calls anymore."
Mr. Burke wants other states to adopt the concept of the Missouri Plan, and he has been telling them so. The reasons seems clear: An emphasis on retail buyers means more bonds at the takedown for his firm's clients and greater profits.
A Tough Sell
So far, he said, it has been tough to convince state housing officials to change an underwriting system they believe works. Officials argue that even if there is retail demand for their bonds, the housing credits are too complex and call-prone to attract smaller investors.
But Mr. Burke says selling to individual investors means better prices because retail buers benefit from the state tax exemption and are generally not subject to the alternatively minimum tax that institutions pay.
"The bonds are always in demand," he said. "Our customers are willing to pay a premium for these bonds, and we often have to buy them from the secondary market, where they have been marked way up."
Earlier this year, he took that argument to the Montana Board of Housing. Noting that Edward D. Jones has some 16,700 clients through 21 offices in the state, Mr. Burke spelled out in a five-page letter how he believed demand from the state's retail buyers could save the agency interest costs.
The problem, he said, is that too few bonds have been allocated to his firm, while the rest were being marked up and flipped to the secondary market for quick profits.
Richard Kain, administrator of the Montana Board of Housing, replied, "Our mission continuese to be to get the lowest possible costs. We feel we've been quite successful."
Wall Street firms agree, saying the push for greater allocation of bonds for retail buyers is not necessary. They contend that they already work toward aggressive pricings.
"You can look at the stats and see that retail buyers are already in these deals," said a senior executive at a Wall Street firm who declined to be identified. "What you attempt to do is get the agency the best rate possible by selling in whatever combination works best."
Despite criticism of the current method for selling single-family housing bonds, most agree that a majority of housing bonds eventually end up in the hands of retail buyers. Even so, institutions have been the buyer of first choice for underwriters for many reasons.
"Housing bonds are more complex and more difficult to understand," said Mr. Fenton, of Nuveen & Co. "In the bond market, complexity means higher costs."
Others say it is a matter of market savvy.
"Retail buyers usually aren't as sophisticated as institutional buyers," said Peter Fugiel, vice president for research at John Nuveen & Co. "Institutions may want more yield out of it, because everything they do is to the last nickel. Individual investors generally lack the clout it takes to do that."
So far, state housing agencies appear unmoved.
John McEvoy, executive director of the National Council of State Housing Agencies, said there is no effort nationally to change the way bonds are sold. Retail-oriented firms will have to prove that a change is beneficial, he added.
"I would think the proof of the pudding will be in the eating," he said. "All the state agencies are highly price sensitive. If any brokerages can prove they can do it cheaper, they'll make a dent in this business."
