Adherents of the negotiated underwriting of municipal bonds, who are winning the battle -- and have been winning the battle for almost 20 years -- have a new worry.
Bond issuers are telling them their business.
The latest example of this came last week, when First Boston Corp. priced a $200 million revenue bond issue for the Contra Costa Transportation Authority. The pricing wire, for those who have not seen it, carefully noted:
Priority of Orders
1. Contra Costa Retail Orders.
2. Individual Investor Orders who are residents of Alameda, San Mateo, San Francisco, Santa Clara, and Marin counties.
3. MBE/WBE Orders.
4. Group Orders.
5. Designated Orders.
6. Member Orders.
For those readers who do not know what MBE/WBE is, it translates to minority- and women-owned business enterprises. That privileged relationship is part of the story, but not the entire story.
How Underwriting Works
No, this story is really about how underwriting works. And how it usually works is that underwriting firms buy bonds and then sell them to retail and institutional investors. It is not an easy process, by any means -- deciding how to price and bid on bonds -- but it has worked for over a century, and fairly smoothly.
The Municipal Securities Rulemaking Board's G11 (e) states clearly, "Every syndicate shall establish priority provisions." This is because, presumably, the syndicate, which has underwritten billions of dollars of bonds, is professional, knows what it is doing, and can get the job done.
But some issuers during the past few yeas decided it was appropriate for them to take an activist position in regard to their financings and to tell the underwrites how to establish priority provisions.
To a man and woman, underwriters interviewed last week said the Contra Costa situation was, as one put it, "very unusual. I don't think I've seen it specified that precisely before." And, as is often the case when you try to tell someone how to run their business, most of them were pretty disturbed by it.
Some were disturbed by the MBE/WBE provision. I heard the usual grumbling. "Isn't it time to call a halt to this nonsense?" said one portfolio manager. "These people don't want equality. What they want is special privileges."
Others pointed out the difficulty and even cynicism of transferring such "affirmative action" practices to something like municipal bond underwriting. Do bankers who happen to be highly paid and professional members of the industry also deserve a special break because they happen to be a member of a minority group, or because they are women?
But I have written about this kind of thing before, and at length.
'Where is the Logic?'
Others were disturbed by the stipulation that such provisions were made at all. "I understand the push for local retail, but I think there's a real problem here," said one head of a New York-based bond house. "If I live in Southern California, why should I get shut out of these bonds? Where is the logic?"
He continued, "As an underwriter, as the head of a syndicate, I just try to do it as fairly as possible. Of course I try to get in-state buyers in an issue like this one. But with this kind of policy, I think you take away an underwriter's good judgment."
Of course, not every member of small municipal bond firms sees it that way. Tales of managing underwriters "hogging the bonds," to the detriment of smaller underwriters, are common. New York's Metrpolitan Transportation Authority, in particular, fought this practice when it changed the way it did somne of its negotiated business in 1989, after it found out that senior managers were keeping 64% of the bonds they underwrote.
For its part, a spokesman at First Boston Corp.'s San Francisco office, which priced the Contra Costa issue, said that while the priority of orders provision was "unusual," it did not "restrict the transaction" in any way.
Why They Did It
And why did the Contra Costa Transportation Authority make the unusual move of establishing priority of orders? I asked Jeff Davis, an administrative and fiscal officer for the authority.
The first priority, favoring Contra Costa retail orders, and the second, favoring local investors, "is a reflection of the sentiment of our board. It reflects a strong, local priority to voters, and to people who will use our transportation services," said Mr. Smith.
The MBE/WBE provision, meanwhile, which only applies to members of the syndicate Grigsby, Brandford Powell Inc. and Smith, Mitchell & Associates Inc., "reflects a strong commitment to minority participation, up to 20% of the issue, by the board."
And will the board, which plans another issue of around $100 million in about two yers, keep these priorities in place? "We haven't done a post-mortem yet, but I see no reason why the goals of the authority will change," Mr. Davis said.
So, that is why the Contra Costa Transportation Authority did what they did. Adherents of negotiated underwriting take note: because while some of you may be used to playing politics to get business, you may not be used to playing this kind of politics after you get the business.