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The Basics of Municipal Bond Underwriting

Presented By: Darci Doneff

Managing Director, Municipal Trading and Underwriting

Wednesday, January 10th, 2007

The Municipal Market Defined

Definition of the municipal securities market

• Municipal securities are debt obligations issued by states, cities, counties, and other governmental entities to raise money to build schools, highways, hospitals, and sewer systems, as well as many other projects for the public good.

• Municipal Securities are the most important way the U.S. state and local governments borrow money to finance their capital investment and cash flow needs.

Characteristics of Municipal Bonds

Municipal Bonds Carry Unique Characteristics

• The most important distinguishing characteristic of the municipal securities market is the exemption of interest from federal income taxes

• Municipal issuers can therefore borrow at significantly lower interest rates than other debt markets

• There are currently in excess of $2 trillion in outstanding municipal debt

• There are more than 70,000 issuers with over 3 million CUSIPS

Municipal Market ~ Underwriting Volume

2006 Statistics

$390 Billion

Fixed Rate 84%, $329 Billion

Variable Rate 16%, $61 Billion

Negotiated 75%, $294 Billion

Competitive 25%, $96 Billion

A-1

Municipal Market ~ Underwriting Participants

Primary Market Issuers Financial Advisors Bankers Underwriters Sales Staff Investors

Secondary Market Traders Investors

A-2

Municipal Market ~ Participants continued…

Issuers State & Local Governments Special Purpose ~ Authorities, Districts, and Non-Profits

Underwriters and Bankers Senior Manager

May assist issuer and FA with financing plan. Communicates with issuer, FA, and co-managers. Manages the bond sale process.

Co-Managers Adds marketing capability and expands investor base through

local presence, middle market capabilities, or special niche investors.

Supports the sale by committing capital to buy/sell bonds.

Sales Staff Institutional Direct & Pooled Retail

A-3

Municipal Market ~ Investors

Tier 1 Top 100 Accounts Large Arbitrage & Hedge Funds, Bond Funds,

Corporations, Insurance Companies, Money Managers, Mutual Funds, Large Banks

Tier 2 Middle Markets Mid-size Banks, Corporations, Funds, Insurance

Companies, Money Managers, Trusts

Tier 3 Direct Retail Pooled Retail

A-4

Types of Municipal Underwriting

Competitive @ 25% of Market Most General Obligation, AAA Insured and other

straight forward structures. Stable market conditions.

Negotiated @ 75% of Market Relatively complicated transactions Transactions sensitive to small swings in interest

rates. Issuer/Transaction lacks strong investor demand. Volatile bond market.

B-1

Competitive Underwriting Defined

Competitive Underwriting

• Process whereby an underwriter submits a sealed bid to the issuer via electronic, fax or hand delivery

• Issuer selects the underwriter bidding the best (highest) price and the lowest interest cost

• Depending on the size, credit quality and current market conditions an issuer can expect to receive on average 5 separate bids

Competitive Underwriting Process

Issuer Identifies a Capital Need:

Ex. City of Minneapolis

Road Improvements

Determine Sale Date & Time

Closing:

Distribute proceeds to issuer and road construction begins

Issuer Accepts Bids & Awards

Based on Low Interest Cost

Locate Buyers Dealer Takes Issue

Into Inventory

Negotiated Underwriting Defined

Negotiated Underwriting

• Process whereby both the purchase price and the offering price for a new issue are negotiated between the issuer and the underwriter

• The underwriter pays the issuer a purchase price and the public the offering price the difference represents the spread the issuer pays

• Underwriters selected to negotiate a new issue generally must first enter into a request for proposal (RFP) process

Negotiated Underwriting Process

Issuer Identifies a Capital Need:

Ex. Hennepin County decides

to build a new Twins Stadium

RFP Process

Interview Bankers

Closing:

Distribute proceeds to issuer and begin construction

Marketing

Locate Buyers Pricing

Competitive vs. Negotiated

CompetitiveNegotiated

Date & Time Set FlexiblePricing Parameters Set FlexibleCall Features Set FlexibleUnderwriting Spread ?? SetMarketing Time Frame ½ day 3 weeksCoupon Bifurcation No YesRetail Priority ?? Yes

Some considerations:

B-2

Deal Economics of Municipal Underwriting

Underwriting Spread

Management Fee $ per $1,000 of bonds issued. Fees to structure the bond issue. If FA structured the transaction, Management Fee is often $0.

Takedown $ per $1,000 of bonds issued. Bond sale “commission.”

Clearance Related Expenses Fixed costs to issue bonds (MSRB, wire fees, etc…)

Out-of-Pocket Expenses Variable costs to issue bonds (travel, copying, etc…) Underwriter’s Counsel

E-3

How Are Prices Set In The New Issue Market?

Municipal new issues are bought and sold on the basis of:

• Credit quality

• Maturity

• Liquidity

• Yield

Yield is the most important element for an issuer and an investor in evaluating the merits of the transaction

F-1

New Issue Pricing Factors

A lot of factors must be taken into consideration for each new issue that is priced.

Factors include:

• What is the prevailing level of interest rates?• What is the supply and demand for the issue?• Creditworthiness of the issuer?• Is the issuer well known?• What is the maturity?• Will it be difficult to find investors for the issue?

Negotiated New Issue Pricing ~ Scheduling

How do we link the schedule with investor interest? Monitor Volume

Forward Supply Time of Year

Size Makes a Difference Large issues get attention of all investors. Small issues somewhat limited to middle market investors,

small money managers, and retail.

Name/Rating/Credit Easy to sell – G.O.’s and bonds related to an essential purpose. More difficult – health care, hospitality, housing, “dirt deals.”

Monitor Economic Data

Monitor Current Events

C-1

Negotiated New Issue Pricing ~ Marketing

How do we match the issue to the right investors?

Structure

Size – some investors have restrictions as to minimize size and population

Underlying Ratings – split ratings can hurt marketability

Credit Enhancement/Insurance

Issuer Name

Call Features

C-2

Pricing ~ Marketing continued…

How do we tailor marketing to a specific issue?

Unique marketing plan for each issue.

Wherever possible, underwriting and sales staff are made aware of the issue at least one month before pricing.

Internal Sales Bulletins

Informational conference calls including Bankers, Underwriters, and Sales Staff to discuss financing plan.

Issue placed on national calendar for maximum exposure.

C-3

Pricing ~ Final Preparations

Two Weeks Prior to Pricing Distribute Preliminary Official Statement (POS) to

potential investors.

Respond to questions from potential investors and other market participants as to market timing, structure, etc.

One Week Prior to Pricing Confirm pricing date with banker and issuer.

Due Diligence Call with issuer, FA, banker, and attorneys.

Call with underwriting team to outline marketing plan

Monitor competing issues in the market.

C-4

Pricing ~ Final Preparations continued….

Day Prior to Pricing Gather price thoughts from co-managers (when

syndicated)

Confirm structure with issuer and banker based on market conditions

Pre-Pricing Call with issuer and banker

Communicate price ideas with investors through sales force

Continue receiving feedback from investors

Underwriting and sales staff finalize plan for the next day’s pricing

C-5

Pricing ~ Day of Pricing

Finalize structure for the price release.

Pricing Call – The Issuer gives the green light to proceed with the pricing

Send out pricing wire to market participants with details of pricing

Run an order period Generally, minimum 1 hour/maximum 2 hours Monitor order flow. Continuously communicate with Sales Staff. Conference call with Issuer, FA, and Banker. Consider changes to price/structure if needed.

C-6

Pricing ~ Day of Pricing continued…

Re-price, if necessary.

Conference call with Issuer and Banker Negotiate the final price. Provide commitment to underwrite. Receive verbal award from Issuer.

After Pricing Banker forwards Final Pricing Summary to Underwriting

Staff for review. Issuer and Senior Managing Underwriter sign the Bond

Purchase Agreement. Senior Managing Underwriter allocates bonds to investors. Issue is “booked” and trades are processed. Secondary trading may begin, usually the day after pricing.

C-7

Pricing ~ Summary

C-9

1 Week Prior to Pricing

2 Weeks Prior to Pricing

Marketing

Scheduling

Pre-Pricing

Pricing

Rep

rici

ng

BPAClosing

Piper Jaffray Municipal Underwriting Overview

Piper Jaffray is a leader in New Issue Underwriting

2006 Rankings:

• Ranked 12th in competitive and negotiated long term issues combined with a par amount $6.6 Billion

• Ranked 4th in number of senior managed long term issues with 452

• Ranked 13th in negotiated long term issues with a par amount of $5.2 Billion and 4th in number of issues with 311

• Ranked 11th in competitive long term issues with a par amount of $1.4 Billion and 6th in number of issues with 141

Including short term issues Piper Jaffray senior managed a par amount of $7.7 billion new issues in 2006. We also completed a substantial volume of co-managed underwritings, financial advisory and loan placements

Municipal Underwriting

Q&A