5.4.2 Underwriting Fees and Expenses
In both negotiated and competitive sales, underwriting fees and expenses (the “underwriter’s discount”, underwriter’s gross spread, or spread) are paid indirectly by the issuer to the underwriter of the bonds. The underwriting fees cover costs incurred by the underwriter and services related to selling the bonds to investors and managing elements of the transaction. The fees also include the underwriter’s commission (or “takedown”).
Components of the underwriter’s discount include the following:
- TAKEDOWN – Normally the largest component of the spread, similar to a commission, which represents the compensation derived by the selling broker or dealer from the sale of the bonds
- UNDERWRITER EXPENSES – Any advertising and printing costs to the underwriter, fees and expenses of underwriter’s counsel, Blue Sky fees and expenses,88 external data services fees, investor road show expenses, out of pocket travel expenses, CDIAC, Committee on Uniform Security Identification Procedures (CUSIP), and The Depository Trust Company (DTC) fees and other similar expenses
- – The amount of compensation for risks incurred by the underwriter in underwriting the bond issue, relating to the difficulty of marketing the issue, bond market conditions, and the amount of bonds remaining to be resold after the execution of the bond purchase agreement. It is rare for there to be any risk component in a negotiated sale.
- MANAGEMENT FEE – Sometimes a fee paid to the managing underwriter for handling the affairs of the syndicate, including, in the case of a negotiated sale, structuring the issue with the issuer
These costs are primarily allocated to the difference between the price an underwriter pays the issuer for the bonds and the price at which the underwriter expects to resell the bonds to investors. Underwriter’s discount is typically reflected in the purchase price of the bonds paid by the underwriters at closing. In some cases, however, issuers must pay these fees from either bond proceeds or, if no proceeds are available because the offering price of refunding bonds cannot exceed the redemption price of refunded bonds, the public agency issuer’s own funds.
Underwriting spreads have tended to decline in recent years due to competition, market factors, and technology. It is difficult to state a rule of thumb for what an underwriting spread should be or what the components should be relative to each other, because of the variables, which can include the type of financing, the credit quality of the debt, the scope of services to be provided by the underwriter, and other factors. Well before the final pricing of the bonds, the public agency issuer should request pricing book information from the underwriter detailing the elements of the expected spread and data on comparable spreads from other recent pricings. Issuers should remember that in a negotiated sale all of the elements of a spread are negotiable. If a financial advisor is involved in the transaction, the advisor should be prepared to analyze the proposed spread and ensure that it is reasonable under all of the circumstances.
Issuers also should be aware that certain costs are embedded within the bids received from underwriters in a competitive sale. These costs and fees are usually not specified in a competitive bid and are outside of the issuer’s control, although the amount of underwriter’s fee is reflected in True Interest Cost (TIC) and is factored into the determination of the winning bid.
The GFOA advises issuers to work with their financial advisors to understand all costs and fees, so that they can be controlled and managed throughout the financing process.89 In addition, a thorough discussion with the issuer’s municipal advisor and other professionals involved in the transaction should be expected. These discussions should occur at the time that compensation is being determined for key members of the financing team, including the financial advisor, bond counsel, and other service providers. As always, cost must be balanced with quality, because it is critical that the issuer receives high quality services and work products from all parties. Furthermore, it may be useful to see what other public agencies in California paid when issuing debt. Historical issuance costs can be found on the California State Treasurer’s DebtWatch database.