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  • rudym12wp

The Top 5 Items for Successful Bond Pricing

This morning I was reminded that pricing bonds is part art and part science. It means requiring an in-depth knowledge of the market and sharp insight into the economic environment, coupled with an understanding of how the investors are going to react. The following are five critical items to my approach to bond pricing, based on over a decade of experience in municipal finance.

1. Understanding the Market Environment

Before pricing an issue, it is very important to understand the present market scenario very clearly. First and foremost, check interest rates for recent fluctuations, trends on inflation, and overall economic conditions. Are these rates to be expected to rise in the near term or fall? No crystal ball type predictions, but as an advisor you should have a good sense of interest rate direction. All these factors are very important because they result in a huge influence over the appetite of the investor and pricing strategy.

This may seem like a no-brainer to most, but it is important to look at the capital improvement plan, while monitoring market conditions. It may make sense to accelerate or delay pricing based on interest rate earnings in a project fund. Will the market provide the best pricing and earning opportunities for the projects?

2. Assessing Credit Quality and Risk

The major determinant of how bonds are priced is the credit quality of the issuer. Typically, the higher the credit rating, the lower the interest rates. The interest rate investors are willing to pay are usually pegged to the issuer rating, since it reflects the risk of the issuer’s ability to pay. A clear and precise assessment of the financial soundness of the issuer is also to be made; for example, the revenue streams, the debt level, and the fiscal policies. The assessment must take into account the existence of external factors, if any, that could potentially impact the financial stability of the issuer.

3. Benchmarking

Through benchmarking against similar issuances in the market, this would allow you to come up with a competitive and realistic price for your bonds. Look at bonds with similar maturities and credit ratings from issuers with economic profiles that would be deemed similar. This benchmarking process is useful in understanding the yield curve for like bonds and sets the pricing baseline, thereby offering a broader perspective, except in consideration of any other unique features which may affect its pricing vis-à-vis the benchmark.

4. Engaging with Investors

Appreciation of one's investor base can be quite contributory to the achievement of bond pricing. This is important because different classes of investors may have different interests in yield, maturity, and risks that go with the issue. This will help in these discussions with prospective investors regarding their preference and interest.

Nickel Hayden has a partnership with BondLink to facilitate direct conversations, roadshows, and other marketing efforts with investors. Issuers should also work with underwriters and their financial advisors to create an effective marketing strategy. The effort will expose you to the parameters your investors are looking for, and in the process, you will be able to give shape to the bond issuance with the ability to still achieve a successful pricing.

5. Flexibility and Timing

This is critical from a timing perspective since this might result in pricing differences. Market conditions may, however, change with time, and one needs to be in a position to adapt to the same. This may include timing changes in an issuance or find the flexibility of the pricing strategy. For this reason, we highly recommend a negotiated bond sale method to provide the flexibility to react to market condition changes. The method of sale debate has been ongoing for some time now and I’m sure I’ll receive an email telling me I’m wrong, but, for Nickel Hayden, we prefer the negotiated method. Reading market conditions and being prepared to pivot could mean the difference between success and failure in a bond issue.

Successful bond pricing is a delicate balance of good market insight with detailed analysis, coupled with keen timing. This five-point checklist presents municipal finance professionals with a better way of wielding through the nitty-gritty complexities of the bond market to correspondingly build a pricing strategy in line with issuer goals and market demands. Always, it is paramount to remember that each issuance of the bond is unique, and tailor-making an approach to success in consideration of these fundamentals will prove quite key.

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