A few weeks ago I wrote a column about this year's volume (Nov. 1: "Pondering a Mystery in the Municipal Market: Are Dealers Selling More, But Enjoying It Less?"), specifically questioning why new-money competitive sales were down, and in general talking about competitive versus negotiated methods of sale.
I asked for some responses, and was pleased to find the following by George Friedlander, managing director of fixed-income portfolio strategy at Smith Barney Shearson, in the firm's Credit Market Comment for Nov. 5.
Friedlander, who is one of the most astute of municipal market watchers, notes on opening that we have had "an ongoing colloquy regarding the relative merits of competitive and negotiated sale." Very few professionals in the industry bother to cross swords, except verbally, with the folks who buy ink by the truckload. George Friedlander is a happy exception, and I am delighted to give him some space.
"Dear Mr. Mysak:
"Given the carnage in the municipal bond market over the past week, we don't have the time or space to rehash the competitive vs. negotiated battle in detail. However, in response to your request for ~answers,' we have a few.
"First, as to why some of us get ~red-in-the-face' reprding the entire argument. While the capital markets tend to be a zero-sum game, it is likely that the use of the negotiated, rather than competitive, sale format for most financings creates a positive sum result for issuers and investment bankers. "It is important to note that the corporate market - common equities, preferred stock, and corporate bonds, - is almost exclusively a negotiated environment, with the exception of the regulated utility sector, where the competitive mode is mandated in some states for some types of financings.
"Why would supposedly more knowledgeable corporate officials choose negotiation if it wasn't effective? And, why shouldn't we get red-in-the-face when a potentially sub-optimal format is pushed aggressively by the Editor of our industry newspaper?
"Second, it isn't the complexity of specific issues that has led the charge toward negotiation, but the complexity of the municipal bond market itself. On the institutional side, the trend toward increased use of derivatives and the narrowing of the institutional market for long-term bonds to household sector surrogates - funds, unit trusts, etc. - both argue for a format where financing structures can.be customized and modified at the time of sale. On the direct retail side - mostly the intermediate sector - pre-sale marketing is often invaluable. Such pre-sale activity is virtually impossible under the competitive format.
Finally, anyone who thinks that a municipal bond market dominated by competitive sales would be a step toward utopia need look no further back in time than the past two weeks. One of the reasons the municipal bond market has acted so badly as rates rebounded is the heavy calendar of competitive offerings over that period, including the heaviest competitive week of the year. Competitive deals can't be repriced or restructured as markets change rapidly, and they are not as often postponed during periods of extreme weakness. These factors clearly contributed to the recent trashing of the intermediate sector of the municipal bond market, in our opinion.
"To be sure, the long period of strength in the municipal bond market may have lured some participants into forgetting about volatility. As we just found out, in spades, volatility can resurface at any point. Issuers arc well served by considering this factor in deciding whether the competitive or negotiated format is likely to work best for a financing program that takes months or years to accomplish."