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UNDERSTANDING MUNICIPAL BONDS How Municipal Bonds Are Sold in a JUNE 2020

anonymous to all underwriters, each underwriter can see the Municpal Bonds–Method of Sale ranking of its own bid relative to competing bids. Therefore, the Many of us are familiar with municipal bonds, either as an issuer, underwriter with the second best bid knows that it ranks second an , or, for a much smaller number of us, a participant and can continuously submit better bids until it holds the top in the industry. Generally speaking, the idea is . This bid competition continues until the predetermined simple. A unit of government needs to borrow money for any timeframe for the expires, unless there is a new top- number of public purposes, and have the capital to ranked bid within the last two minutes of the auction, in which lend to these governments in exchange for a . What case the auction is extended for another two minutes. Eventually, is far less familiar to many is an understanding of the intricacies the underwriter that submits the bid with the lowest TIC for a full of the municipal . As a result, PMA’s Public two minutes will be the winning bidder. See below for a sample group has created the “Understanding Municipal Bonds” series bid summary in an open-auction competitive sale. to help educate our issuer clients on nuanced aspects of the Sample Bid Summary–Open Auction bond market. In this edition, we provide insight on the method of sale options available to issuers when selling their bonds in the (i.e., a public offering of municipal securities). For a public offering, there are two methods of sale for municipal bonds: 1) Competitive sale, and 2) Negotiated sale. A competitive sale requires a financial advisor to post the bond issue on behalf of the issuer to an online portal where underwriters can electronically submit bids while competing for the bonds. In this auction-style platform, the underwriter that submits the best bid (lowest rate) is awarded the bond issue. The winning underwriter then re-offers the bonds to its network of investors. Source: MuniAuction 6/10/20 While an underwriter uses its own capital to initially purchase Competitive Sale–Closed Auction the bonds before re-offering them to investors, an underwriter itself is not considered an investor. Therefore, the underwriter’s The second type of competitive platform is the closed-auction in intention is not to hold the bonds for an extended period of time. which each bidding underwriter can only submit one bid and does Instead, an underwriter prefers to locate investors prior to, or as not know the bid’s ranking throughout the bid window. Therefore, soon as possible after, the date of the bond sale. each underwriter is compelled to submit its best and final bid without knowing where the bid ranks. The timing is simpler as It’s important to understand the term “best bid.” In a previous well, as each underwriter just needs to submit its best and final bid edition of our educational series, found here, we discussed the by a pre-determined time. See below for a sample of a summary different ways the cost for a financing is measured. In a of bids that occurred in a closed-auction competitive sale. bond summary report, it’s typical to see variations of the interest cost defined in the following ways: Net Interest Cost (NIC), True Sample Bid Summary–Closed Auction Interest Cost (TIC), All-inclusive Cost (AIC), and (also known as the Bond Yield). For the sake of a competitive sale, the best bid is determined as that which provides the lowest TIC. The TIC takes into account the two items that the bidding underwriter can control: 1) the interest rates on the bonds, and 2) the Underwriter’s Discount, which is best understood as the fee paid by the issuer to the underwriter to sell the bonds. Competitive Sale–Open Auction It’s worth noting that in today’s industry, there are two platforms on which an issuer can sell its bonds via a competitive sale. The Source: PARITY, i-Deal LLC, 6/4/20 first is an open-auction platform in which a bidding underwriter Certain circumstances might justify using one platform over the has the opportunity to improve its bid as many times as it other, so we encourage readers to consult your PMA Advisor would like. While the exact terms of the bids themselves remain when deciding which platform to use for a competitive bond sale. PMA SECURITIES | MUNI BONDS 101 JUNE 2020

Negotiated Sale The negotiated sale process is quite different than a competitive It’s also important to note that when municipal bonds are priced, sale. In a negotiated sale, the issuer pre-selects the underwriter, they’re often priced relative to the AAA Municipal Market Data either through an existing relationship or a Request for Proposal (MMD) index, which is the most broadly utilized in the (RFP) process. The advantage of this approach is that because industry. The MMD changes on a daily, or even hourly, basis so the underwriter is engaged prior to the sale of the bonds, the comparing absolute rates from a bond sale occurring on one day underwriter’s salespeople can take the time to pre-market the to another bond sale occurring another day is not a fair, apples- bonds to its network of investors and, in doing so, build investor to-apples comparison. In order to accommodate for a constantly interest in a targeted way that may not exist in a competitive changing MMD curve, the industry looks at the spread to MMD sale. On the day of the bond sale, the underwriter solicits orders for each bond pricing. This spread, and not necessarily the from its investors during the “order period” required to finalize absolute , determines how the investing community the exact interest rates on the issuer’s bonds. If soliciting retail views the issuer’s and determines how well or poorly a investors or regional financial institutions are a priority for bond issue may have fared in a particular pricing. It’s important to the issuer, then a targeted order period specific to the retail note that this type of comparative analysis done in a negotiated and regional community can be implemented, sale is not required in a competitive sale, because in the latter, which is another benefit of the negotiated sale process. A the issuer knows it’s likely receiving the best interest rates in a disadvantage of the negotiated sale is that the issuer has limited public offering. the distribution of its bonds to a pre-selected underwriter or, Determining the best sale method and platform requires in the case of a larger issue, more than one underwriter. additional due diligence regarding the state of the municipal When bonds are sold competitively, there is no limit to the bond market, the of the issuer, and the structure number of underwriters and their unique distribution networks and size of the particular bond issue in question. We recommend that can bid on an issuer’s debt. Another disadvantage of the that PMA clients make this decision in collaboration with our negotiated sale is that the issuer doesn’t have the same level of PMA team. For that, or any other questions, information as the underwriter. However, the issuer can mitigate please contact any of PMA’s Public Finance advisors below. this imbalance by retaining a financial advisor to represent the issuer in negotiations with the underwriter. In fact, GFOA Best Next Edition Muni Bonds 101 Practices found here, explicitly recommends that an issuer “hire Understanding Municipal Bonds a municipal advisor prior to the undertaking of a debt financing In our next edition, we’ll shed further insight on the sale process unless the issuer has sufficient in-house expertise and access to with a discussion of the investors and the factors that impact the current bond market information.” of municipal bonds.

Bob Lewis Tammie Beckwith Schallmo Michele Wiberg SVP, Managing Director–IL SVP, Managing Director–IL SVP, Chief Sales & Marketing Officer 630.657.6445 630.657.6446 414.436.1834 [email protected] [email protected] [email protected]

Andrew Kim Stephen Adams Brian Della Steve Pumper Director, Public Finance–IL Director, Public Finance–IL Director, Public Finance–WI Vice President–MN 630.657.6449 618.604.7677 414.436.3523 612.509.2565 [email protected] [email protected] [email protected] [email protected]

Financial Strategies for Stronger Communities.tm This document was prepared by PMA Securities, LLC for clients of the firm and its affiliated PMA entities, as defined below. It is being provided for informational and/or educational purposes only without regard to any particular user’s investment objectives, financial situation or means. The content of this document is not to be construed as a recommendation, solicitation or offer to buy or sell any , financial product or instrument, or to participate in any particular trading strategy in any jurisdiction in which such an offer or solicitation, or trading strategy would be illegal. Nor does it constitute any legal, tax, accounting or investment advice of services regarding the suitability or profitability of any security or investment. Although the information contained in this document has been obtained from third-party sources believed to be reliable, PMA cannot guarantee the accuracy or completeness of such information. It is understood that PMA is not responsible for any errors or omissions in the content in this document and the information is being provided to you on an “as is” basis without warranties or representations of any kind. The analysis or information presented may also contain hypothetical projections and/or past performance that have certain limitations. Past performance does not guarantee future results and no representation is made that the results are accurate or complete or that any results will be achieved. Securities, public finance services and institutional brokerage services are offered through PMA Securities, LLC. PMA Securities, LLC is a broker-dealer and municipal advisor registered with the SEC and MSRB, and is a member of FINRA and SIPC. Prudent Man Advisors, LLC, an SEC registered investment adviser, provides investment advisory services to local government investment pools and separate accounts. All other products and services are provided by PMA Financial Network, LLC. PMA Financial Network, LLC, PMA Securities, LLC and Prudent Man Advisors, LLC (collectively “PMA”) are under common ownership. Securities and public finance services offered through PMA Securities, LLC are available in CA, CO, FL, IL, IN, IA, NY, MI , MN , MO , NE, OH, OK, PA, SD, TX and WI. This document is not an offer of services available in any state other than those listed above, has been prepared for informational and educational purposes and does not constitute a solicitation to purchase or sell securities, which may be done only after client suitability is reviewed and determined. All mentioned herein may have varying levels of risk, and may not be suitable for every investor. PMA and its employees do not offer tax or legal advice. Individuals and organizations should consult with their own tax and/or legal advisors before making any tax or legal related investment decisions. Additional information is available upon request. ©2019 PMA Securities, LLC