CDFA Spotlight:
Gross Spreads Continue to Decline

By Stan Provus

Preface

This article reviews the trends in the underwriter’s discount or “gross spread”. Gross spreads refer to the to the income earned by the underwriting syndicate as a result of differences in the price paid to the issuer for a new issue of municipal bonds, and the prices at which bonds are sold to the investing public, usually expressed in points or fractions thereof or as dollars per thousand bonds. This spread can have a large impact on the sale of an issuance.

Gross Spread

"Spread” or “gross spread” or “gross underwriting spread” means the same thing along with the term “underwriter’s discount” in a municipal bond sale. The spread terms do not refer to some kind of spread you put on bread that combines odd combinations of ingredients such as peanut butter and ketchup and is, thus, “gross.” Rather they refer to the income earned by the underwriting syndicate as a result of differences in the price paid to the issuer for a new issue of municipal bonds, and the prices at which bonds are sold to the investing public, usually expressed in points or fractions thereof or as dollars per thousand bonds. A gross spread of $5/1,000 bonds on a million dollar issue would cost $5,000.

Spread generally has three components in a negotiated sale:

1. Expenses—the costs of operating the syndicate for which the lead manager may be reimbursed.

2. Management fee—Usually paid to the lead manager for providing services to the issuer and for handling the affairs of the underwriting syndicate.

3. Takedown—the largest component of spread, similar to a sales commission, which represents income derived from the sale of bonds. If a member of the syndicate sells bolds, such seller is entitled only to that portion of the takedown known as the concession.

In a competitive sale, the gross spread, is the difference between the price an underwriter pays the issuer and the price at which the underwriter sells bonds to investors. Gross spreads consistently average less for competitive sales than negotiated sales. However, spreads between the two are not necessarily comparable. For example, in a negotiated sale the cost of the underwriter structuring and sizing the deal and performing other tasks is included in gross spread (Management Fee). In a competitive sale the cost of a financial adviser would not be included in the spread but would be a cost of issuance item.

Gross Spreads Continue to Decline

The following table shows how average gross spreads have declined over the past ten years. Amounts represent dollars per $1,000 face value of bond issues (Source: Bond Buyer)

Year	Competitive	Negotiated
1996	7.53	7.83
1997	6.75	7.32
1998	6.16	7.23
1999	6.85	7.17
2000	6.39	6.73
2001	6.11	6.52
2002	5.89	6.20
2003	5.58	5.80
2004	6.31	5.53
2005	6.31	5.55

Over the past decade, gross spreads on competitive sales declined by 16.2%. Spreads on negotiated sales declined by 29.2 %. These narrowing spreads reflect an increasingly competitive municipal market place. It seems a long time ago when spreads were considerably higher. For example, the gross spread on competitive and negotiated sales in 1986 were $10.86 and $13.21, respectively.

This article is intended to provide accurate and authoritative information in regard to the subject matter covered. The author and CDFA are not herein engaged in rendering legal, accounting or other professional services, nor does it intend that the material included herein be relied upon to the exclusion of outside counsel. CDFA is not responsible for the accuracy of the information provided in this fact sheet. The information provided has been collected from a variety of sources. Those seeking to conduct complex financial deals using the tools mentioned in this document are encouraged to seek the advice of a skilled legal/consulting professional.

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