In A Nutshell...
- Underwriting fees are based on a percentage of par amount.
- Underwriting fees are currently at historical lows due to weak issuance volumes and increased competition among underwriters.
- Understanding the impact of credit quality, deal size, deal type and competition on fees can help hospitals lower their costs of issuance.
How Are Underwriting Fees Calculated?
Underwriting fees, also known as underwriter’s discount, are negotiated between bond underwriters and borrowers for each bond offering depending on factors including credit quality, transaction size, and market conditions.
Underwriting fees are quoted in dollars per $1,000 bond. For example, a $400,000 fee on a $50 million par amount will be discussed as $8/bond.
In a typical tax-exempt bond offering, underwriting fees can represent more than half of total costs of issuance, with the balance consisting of legal expenses, issuer fees, rating fees, etc. Since these other costs tend to be fixed, as deals get larger, underwriting becomes a large component of total borrowing costs.
How Much Are Hospitals Paying?
According to Thomson Reuters data, underwriting fees across all muni sectors plunged 17% since 2009. This significant compression in fees is blamed on low issuance volumes and the resulting heightened competition among underwriters. Slow volumes have been particularly evident in healthcare as providers continue to wait on the sidelines for more clarity on industry reform before borrowing for large capital projects.
Faced with slow volumes, bond underwriters have had little choice but to hang on in the hope that business picks up or competitors drop out. Meanwhile, bankers are fighting over fewer deals and will accept lower fees in return for a shot at maintaining market share. For the period from January through May 2013, underwriting fees for fixed rate hospital revenue bonds have averaged $6.40/bond (0.64%), or $6.90/bond if premium proceeds are excluded.
What Affects Underwriting Fees?
In order to successfully negotiate underwriting fees, hospitals ought to have a basic understanding of the key factors that drive these fees, including: credit quality, deal size, deal type, competition, additional services, and market environment.
Credit quality. As is usually the case in the capital markets, risk is the single largest determinant of return, and underwriters are not exempt. The lower the hospital’s bond rating, the more underwriters will charge to find investors (see chart on left).
Deal size. The size of the debt offering also affects how much underwriters charge as a percentage of proceeds. Much of the underwriting work is the same regardless of deal size, so as deals get smaller, underwriters increase fees as a percentage of the deal in order to meet minimum revenue targets. Through May 2013, the median fee for deals below $20 million was $8.20/bond.
Deal type. The type of financing also has an impact on fees, although this is more difficult to quantify. Selling bonds through a firm’s retail network involves paying broker commissions and is more costly than if the bonds are placed directly with institutional investors, but retail investors can boost marketability and ultimately help achieve a lower cost of funds. Similarly, refundings involve shorter maturities than “new money” offerings and lower distribution costs.
Competition. Lack of competition among underwriters frequently results in borrowers paying higher fees, particularly if the hospital does not have access to market comparables showing what other borrowers are paying.
Additional services. Underwriters will often argue that they should be compensated for additional services provided. In reality, as more hospitals hire independent financial advisors, underwriting has become commoditized and underwriters have fewer opportunities to create value besides achieving lower yields on pricing day. This limited role is fine with regulators, see MSRB: Bond Underwriter Can Be BFF, But Not FA.
Market environment. Most industry participants agree that the current seller’s (borrower’s) market for municipal bonds is helping to keep underwriting fees low. When the markets start to tighten, hospitals can expect to see underwriting fees rise --along with yields, of course—as happened following the 2008 market crisis.
How Can Hospitals Better Negotiate Underwriting Fees?
There are a few steps hospital financial executives can take to better position for negotiating underwriting fees:
- Get market comps. Knowledge is power. Ask your financial advisor to analyze what other hospitals are paying for underwriting and be sure the analysis adjusts for differences in credit quality, size, and other variables previously discussed. Also, market conditions can change quickly, so the information needs to be timely.
- Encourage competition. Even a limited RFP among a handful of firms will do wonders to keep fees down. As a bonus, some proposals may even present new ideas the hospital hasn’t yet considered.
- Dual track structures. If a bank placement can be an alternative to a public bond offering, the hospital can use it as bargaining chip since bank placements involve minimal upfront fees.
- Don't forget the big picture. Other attributes --such as superior distribution capabilities-- may be more difficult to measure, but can create significant savings over time and should not be ignored.
Now is an opportune time for hospitals to take advantage of attractive market conditions and negotiate favorable fee arrangements with their bond underwriters.
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