Negotiated bid

What Is Negotiated Bid?

A negotiated bid, often referred to as a negotiated sale or negotiated underwriting, is a method of issuing new securities where the terms of the offering are determined through direct discussions between the issuer and a selected underwriter, rather than through a competitive bidding process. This approach is a common practice in Capital Markets, particularly for new debt offerings like municipal bonds or corporate securities. The negotiated bid process allows for flexibility in structuring the deal and can be preferred in certain market conditions or for complex issues.

History and Origin

The practice of issuing securities via a negotiated bid has evolved alongside the development of public and private capital markets. Historically, municipal bond sales were predominantly conducted through competitive bidding, where multiple underwriter firms would submit bids, and the bonds would be awarded to the firm offering the lowest interest cost to the issuer. However, over time, the negotiated method gained prominence, particularly for issues with unique characteristics, those from lesser-known issuers, or during volatile market periods. This shift was partly driven by the desire for greater flexibility in tailoring bond structures and the perceived benefits of a deeper working relationship between the issuer and the underwriting team. Today, negotiated sales account for a significant portion of municipal bond issuance, even though competitive sales are often cited in studies as potentially offering lower interest costs.⁶ The evolution of the regulatory environment, including various Securities and Exchange Commission (SEC) rules and exemptions for securities offerings, has also shaped how negotiated bids are conducted, providing frameworks for disclosure and investor protection.⁵

Key Takeaways

• A negotiated bid involves direct discussions between an issuer and an underwriter to determine the terms of a new securities offering.
• This method is an alternative to competitive bidding and is often chosen for its flexibility, speed, and ability to tailor complex issues.
• Key terms negotiated include the interest rate, purchase price, and call features of the securities.
• Negotiated bids are prevalent in the municipal bond market and are frequently used for complex or unique offerings.
• While offering benefits like timing flexibility, negotiated sales may result in higher underwriting costs compared to competitive sales.

Interpreting the Negotiated Bid

In a negotiated bid, the agreement reached between the issuer and the underwriter is crucial. The terms reflect not only current market conditions but also the specific needs of the issuer and the underwriter's assessment of investor demand. For instance, the agreed-upon underwriting spread—the difference between the purchase price the underwriter pays the issuer and the public offering price—indicates the compensation for the underwriter's services, including marketing and distribution. A higher spread might suggest greater perceived risk or complexity of the issue. The negotiation process aims to find a balance between the issuer's desire for a low borrowing cost and the underwriter's need to successfully sell the securities to investors at a profitable price. The success of a negotiated bid is often measured by whether the securities are placed efficiently and at terms acceptable to both parties.

Hypothetical Example

Imagine the city of Greensburg needs to finance a new wastewater treatment facility. Instead of a competitive bid, they opt for a negotiated bid due to the project's unique revenue stream and the city's limited credit history. The city's financial advisor helps them select an investment banking firm as the lead underwriter.

Over several weeks, the city and the selected underwriter engage in detailed discussions. They negotiate the principal amount of the municipal bonds to be issued, the projected interest rate range, and specific call features that would allow the city to redeem the bonds early if rates fall. The underwriter conducts extensive due diligence on the city's finances and the project, then pre-markets the bonds to potential institutional investors to gauge interest. Based on this feedback and ongoing market analysis, they finalize the pricing, coupons, and other terms. This negotiated bid ensures the bonds are tailored to the market's appetite for this specific type of project, rather than relying on a general market auction.

Practical Applications

Negotiated bids are widely used across various segments of capital formation. In the municipal bond market, they are frequently employed for complex financings, such as those for revenue bonds with intricate security structures, or for issuers that are less familiar to investors. For instance, according to a March 2024 report by the Municipal Securities Rulemaking Board (MSRB), sectors like electric power, healthcare, and housing overwhelmingly utilize the negotiated market. Additionally, lower-rated issues, refunding issues, and taxable issues are more likely to be sold through negotiation.

Be⁴yond municipal finance, negotiated bids, or negotiated underwritings, are standard for most corporate securities offerings, including initial public offerings (IPOs). In these cases, the issuer and the lead underwriter work closely to determine the offering price, the number of shares or bonds, and the overall marketing strategy. This collaborative approach is essential for large, complex, or first-time offerings where market reception is uncertain and specialized expertise is required. The latest statistics from the Securities Industry and Financial Markets Association (SIFMA) continue to show that negotiated sales represent a substantial portion of overall municipal bond issuance activity.

##³ Limitations and Criticisms

Despite their advantages, negotiated bids are not without limitations. A primary criticism is the potential for higher borrowing costs compared to competitive sales. Studies have indicated that underwriting spreads may be greater in negotiated transactions. Cri²tics argue that the lack of direct competition among multiple underwriters can reduce the incentive for the selected underwriter to offer the lowest possible interest rate to the issuer.

Another limitation lies in the transparency of the process. While competitive sales are openly bid, the negotiated bid process involves private discussions, which can raise concerns about fairness and public accountability, especially for governmental entities. To mitigate this, issuers often engage an independent financial advisor and bond counsel to represent their interests and ensure the terms are reasonable. Furthermore, while the flexibility of a negotiated bid allows for market timing, attempts to "time the market" can be speculative and do not guarantee better outcomes.

##¹ Negotiated Bid vs. Competitive Bid

The fundamental difference between a negotiated bid and a competitive bid lies in how the terms of a new securities issue are determined.

While a negotiated bid offers benefits like greater control over the offering structure and the ability to adapt to volatile market conditions, a competitive bid often promises lower borrowing costs due to direct competition. Issuers typically choose between the two methods based on the specific characteristics of the securities offering, prevailing market conditions, and their own financial goals.

FAQs

What types of securities commonly use a negotiated bid?

Negotiated bids are frequently used for municipal bonds, particularly those with complex structures, weaker credit features, or for new issuers. They are also standard practice for most corporate public offerings, including initial public offerings, and private placements.

Why would an issuer choose a negotiated bid over a competitive bid?

An issuer might choose a negotiated bid for several reasons, including the desire for greater flexibility in structuring the bond issue, the ability to time the market effectively in volatile conditions, the need for specialized advice from an underwriter for complex or unusual financings, or to foster a closer working relationship with an underwriting firm.

What are the main terms negotiated in a negotiated bid?

The primary terms negotiated in a negotiated bid typically include the purchase price of the securities (what the underwriter pays the issuer), the public offering price (what investors pay), the interest rate or yield, and any specific features of the security, such as call features or redemption provisions.