Primary Financing for Municipal Securities

The primary market process determines how municipal bonds are priced, who underwrites them, and what disclosures investors receive. This unit covers the sale methods, syndicate mechanics, underwriting spread, and disclosure rules tested on the Series 7.

Competitive Sale

• The issuer publishes a notice of sale specifying the terms and inviting sealed bids from underwriting syndicates
• The syndicate offering the lowest net interest cost (NIC) or true interest cost (TIC) to the issuer wins the bid
• Common for general obligation (GO) bonds (many issuers are required by law to sell GOs competitively)
• The notice of sale includes: par amount, maturity schedule, call provisions, delivery date, bid specifications, and good-faith deposit requirement

NIC vs. TIC:

• NIC (Net Interest Cost): A simple average of the coupon rates, weighted by maturity. Does not account for the time value of money
• TIC (True Interest Cost): Accounts for the time value of money, making it a more accurate measure of the issuer's borrowing cost. TIC is the more modern method

Exam Tip: Gotchas

• NIC does NOT account for time value of money; TIC does. If a question asks which method is more accurate, TIC is the answer.
• The notice of sale is used ONLY for competitive sales, not negotiated sales.

Negotiated Sale

• The issuer selects an underwriter (or syndicate) and negotiates the terms of the offering directly
• More common for revenue bonds and complex financings
• Allows the underwriter to pre-market the issue and gauge investor demand before pricing
• The issuer has more flexibility but may receive less competitive pricing

Exam Tip: Gotchas

• GO bonds = competitive; revenue bonds = negotiated. This is the default pairing, though exceptions exist.
• MSRB Rule G-37 (pay-to-play) prohibits a dealer from doing negotiated underwriting business with an issuer for two years after making a political contribution to an official of that issuer. This restriction applies to negotiated underwritings only, not competitive bids.

Private Placement (Private Offering)

• Bonds are sold directly to a small number of institutional investors without a public offering
• Avoids the costs of a public offering and underwriting
• Less liquidity for the investor since these bonds are not publicly traded

Syndicate Formation and Structure

When a syndicate is formed to underwrite a municipal issue, members sign a syndicate letter (also called the syndicate agreement or agreement among underwriters). This document establishes:

• Each member's participation percentage (share of the issue)
• The type of syndicate account (eastern or western)
• Order priority rules
• The manager's authority to run the books

Good-faith deposit: Typically 1% to 2% of the total par value of the issue. This deposit accompanies a competitive bid to show the syndicate is serious. If the syndicate loses the bid, the deposit is returned. If the syndicate wins, the deposit is applied toward the purchase price.

Syndicate Account Types

There are two types of syndicate accounts, and the exam frequently tests the difference:

Think of it this way: In an eastern account, everyone is in it together. If one member cannot sell its bonds, the remaining unsold bonds get redistributed to all members based on their original participation percentages. In a western account, each member is on its own: sell your share or eat the loss yourself.

Exam Tip: Gotchas

• Eastern = Undivided = shared liability. Even if you sell all your bonds, you are still responsible for a portion of unsold bonds from other members.
• Western = Divided = individual liability. You are responsible only for your own allocation.
• Most municipal syndicates use eastern (undivided) accounts.

Underwriting Spread

The underwriting spread is the difference between the price the syndicate pays the issuer and the price at which the bonds are sold to the public. It has three components:

• Management fee: Paid to the managing underwriter (syndicate manager) for structuring, coordinating, and running the syndicate. This is typically the smallest portion of the spread
• Additional takedown: Paid to each syndicate member for taking on the risk of purchasing bonds from the issuer
• Selling concession: Paid to the firm that actually sells the bonds to the investor. This is typically the largest portion of the spread

Total takedown = additional takedown + selling concession (the spread minus the management fee)

Think of it this way: The management fee goes to the boss (the manager who organizes everything). The additional takedown goes to the syndicate members who put capital at risk. The selling concession goes to whoever closes the deal with the investor, and that could be a syndicate member or even a non-member selling group firm.

Selling group firms are dealers who help sell bonds but are not members of the syndicate. They receive only the selling concession (not the additional takedown), and they have no financial liability for unsold bonds.

Exam Tip: Gotchas

• Selling concession = largest part of the spread. Management fee = smallest part.
• Selling group firms get ONLY the concession. They are not syndicate members and bear no risk for unsold bonds.
• Total takedown = concession + additional takedown. It does NOT include the management fee.

Order Priority

When a new municipal issue is oversubscribed (more demand than supply), the syndicate must allocate bonds according to a priority system. MSRB Rule G-11 requires the managing underwriter to disclose order priority to syndicate members. The typical priority order is:

1. Presale orders: Orders received before the bonds are formally offered (before the syndicate wins the bid or terms are finalized)
2. Group (net designated) orders: Orders where the profit is shared among all syndicate members based on participation percentages
3. Designated orders: The buyer designates which syndicate members receive credit for the sale
4. Member orders: Orders placed by a syndicate member for its own account or for its own customers

Think of it this way: Presale orders come first because they represent strong demand before the deal even closes. Group orders benefit the whole syndicate, so they rank next. Member orders rank last because they only benefit one firm.

Exam Tip: Gotchas

• The standard priority is presale, group, designated, member. Group orders rank above member orders because group orders benefit the entire syndicate.
• The issuer can set a different priority in the notice of sale or bond purchase agreement.

Official Statements and Disclosure

The official statement (OS) is the municipal equivalent of a prospectus: the primary disclosure document for a new municipal issue.

• The POS is sometimes called the "red herring" (analogous to the preliminary prospectus for corporate securities)

SEC Rule 15c2-12 requires underwriters of municipal offerings (over $1 million) to:

• Obtain and review the OS before bidding or purchasing
• Deliver the OS to investors
• Ensure the issuer enters into a continuing disclosure agreement to post ongoing financial information to EMMA (Electronic Municipal Market Access)

MSRB Rule G-32 requires dealers selling new-issue municipal securities to deliver the official statement to buyers by settlement. Under the "access equals delivery" standard, dealers can satisfy this by notifying the buyer that the OS is available on EMMA.

Exam Tip: Gotchas

• Official statements are NOT filed with the SEC. Municipal securities are exempt from SEC registration. However, underwriters must still obtain, review, and distribute the OS under Rule 15c2-12, and submit it to EMMA under Rule G-32.
• SEC Rule 15c2-12 applies only to offerings over $1 million.
• The POS lacks final pricing. It contains everything except the final price, yield, and coupon rate.