Fixed Income Securities:

NEW ISSUE MUNI’S VS. SECONDARY PURCHASES

An Apples-to-Apples Comparison?

We live in a society that operates in a perpetual state of innovation and advancement, and as such, we are continuously bombarded with the message that newer is always better. But is that always the case?

Consider new issues of municipal bonds. Most would assume that a new issue would be perfectly priced based on current market conditions, interest rates, credit ratings, maturities, call dates, etc. Most investors also assume that new issues have no cost associated with their purchase, as they are priced “net to the customer”.

AN INDUSTRY SECRET:

It’s not uncommon to find higher yields on secondary market purchases of fixed income securities— in fact, a diligent search for appropriate secondary market municipal offerings OFTEN turns up higher yielding securities with similar sizes, ratings, and risk profiles. The following illustration compares new issue securities with secondary offerings available during the same period: GRAFICO

Why Do “Commissionless” New Issue Bonds Often Yield Less Than Similar Secondary Securities?

The answer is simple: new issue municipal bonds usually (if not always) contain underwriting fees, referred to as underwriter discounts in documents or as takedowns on offering sheets. (Obviously, underwriters are paid for the services they render, and any costs associated with the marketing of securities will reduce the yields/returns of those securities.)

There are two types of underwriting structures: a negotiated sale and a competitive issue. Each structure can influence the underwriting fees, the proceeds awarded to the issuer, and the risk to the underwriter. Other contributing factors include the size of the issuance, ratings, maturity schedule, and current market conditions.

• Negotiated sales: Issuers determine the underwriter’s discount before bonds are priced and marketed to the public. In today’s environment this typically ranges from approximately $3.75 to$4.00 (0.375% to 0.40%) per bond for an investment grade name across the entire issue. Underwriters usually will take this total amount and apply a takedown in shorter maturities to be$1.00 -$1.25 per bond (0.10% to 0.125%) and scale up to $4.50 to $5.00 per bond with maturities over 10 years.
• Competitive issues: Issuers select underwriters through a bid process. Underwriters establish a price and yield that meets the needs of the issuer as well as their desired level of compensation and acceptable level of risk. If pre-sale orders exist prior to the bid, the underwriting spread is typically less. When there are very few orders, underwriters typically increase the spread to account for their increased risk. Typically, the spread ranges from 0.125% on the short end and up to 1% on the long end of the curve. In this structure, supply and demand influences risk and yield.

THE PUNCH LINE:

SB Value constantly surveys the market to find the best available pricing and yields across both primary market and secondary market securities for our clients to increase portfolio performance. Comparing new issue yields, credit ratings, sizes, and maturity schedules with previously issued secondary market securities will often produce a greater total return opportunity... and a more knowledgeable bond buyer.