There's a direct connection between the smell of a thing and its impact on the stomach. and when an exceptionally abusive scent wafts by, it results in real gastrointestinal pain. That's happening all the time, now that the general press is running negotiated underwriting "stories."
Most repellent are the generalizations now being cast about by even the reputable newspapers. The New York Sunday Times, for example. ran a piece eight days ago that stacked misunderstanding upon misinformation, threw in some miscalculations, and threatened the municipal underwriting business. Understandable, perhaps, given the intricate nature of the negotiated-versus-competitive subject, but in no way responsible.
It is, in fact, possible to shed some light on why deals are negotiated in the first place, how the method can result in the best pricing available, and how in many cases negotiated fees and bond pricings are actually lower than their competitive counterparts.
First, one must concede that an overwhelming majority of negotiated deals are priced below the market to make sure they sail into investors' hands. One abovereproach source says that from 70% to 80% of the negotiated deals sold over the past two years "were not well priced." The yields on these deals were at least 10 basis points higher than they needed to be, costing the issuers quite a bit.
But does this largesse indict the method itself? Ah, would it were that simple.
Two major aspects of an underwriting must be examined: the upfront fee derived from the spreads; and the interest cost. Average negotiated spreads for 1992 were only 30 cents higher than average competitive spreads. Several neutral observers now say that negotiated spreads for deals larger than $100 million are now uniformly lower than competitive spreads.
So issuers pay less up front, but do they pay more on interest costs? Absolutely not. Wisconsin, Massachusetts, Oklahoma, and Los Angeles County get consistently lower interest costs through negotiated underwritings. And not just a little lower, but a lot lower.
Connecticut, furthermore, conducted a study of its own financings in 1992 that concluded that effective bond pricing was completely divorced from whether the deal was negotiated or competitive.
Here are some recent observations on negotiated deals from municipal professionals, all of whom have been rankled into anonymity by the misinterpretations of the general press:
* "The State of Wisconsin, through its department of administration and capital finance, does an absolutely superb job."
* "In Massachusetts, the treasurer's office -- specifically the deputy treasurer of debt management -- teams up with the administration and finance people for an incredible result. They do much better than they could do competitively."
* And from a former state official, "What if you only get two bids in a competitive sale? It's just not that simple. There is definitely a time and a place for negotiated underwriting."
The major reasons for going negotiated have often been cited, from presale work to fine-tuning the structure, but perhaps the most convincing argument is pricing flexibility. In a competitive deal, you're pretty much locked into a price 15 days before the bonds hit the Street: if the market declines after that advance notice of sale, well, ouch.
Today's market is so heady, with cash rushing in from so many corners, that the chance of its rushing back out is enormous. Fifteen days can be an awfully long time.
At the same time, it's obvious that Wisconsin is a world apart from, say, Louisiana. In February, underwriters for Louisiana sold more than $600 million of bonds in 40 minutes; the books were closed while the order period was still going on, enraging local underwriters and national buyers alike. The bonds flew out partly because they were priced very cheap just when demand for the $479 million insured piece was peaking.
Risk-avoidance actions like these (as well as the omnivorous greed behind New Jersey's syndicate manipulation and fee-splitting in Boston) hurt everyone. Mutual funds hypocritically complain that they didn't get enough of those high coupons; syndicate members are tantalized by rewards that are never as great as their risks; and, yes, the taxpayer gets to foot the bill through misspent public resources.
In the end, only one factor separates the Wisconsins from the Louisianas: the sophistication of the public officials. Savvy issuers know the market levels well before their debt is priced. They have a handle on what's moving rates today, yesterday, and last week. And they are not unprepared for what might move rates down the day before their bonds are sold.
The Connecticut study concludes, "Through aggressive negotiation with its underwriters, Connecticut continues to obtain yields and fees on its negotiated general obligation issues which compare favorably with ... standard benchmarks in the municipal bond industry and similar competitively bid issues."
It makes little sense for The Bond Buyer to quibble over whether the general press writes $18 million of interest costs when it really means $1.8 million, or to point out that any issuer getting noncallable, long-maturity term bonds when rates are at obscene lows is being smart.
It's just that, with misreporting, Maalox doesn't do the trick.