U-M achieves significant savings through new online bond auction process
Like many public and private organizations, the university issues tax-exempt bonds when it finances major capital initiatives such as the construction of new buildings, renovation of existing facilities and large equipment purchases. Bonds also are issued to refinance outstanding debt as interest rates decline.
When it issued nearly $185 million in bonds in February to refinance some of its outstanding fixed-rate debt, the university used, for the first time ever, an innovative online auction tool called MuniAuction. The auction works somewhat like eBay, with underwriters competing in real time to outbid each other by offering their lowest possible interest rates for the bonds being issued. Underwriters are firms that purchase bonds and then resell them to individuals and institutions.
Through MuniAuction, the university achieved an interest rate of 3.26 percent with an average maturity on the bonds of 10.3 years.
“Estimating the savings from a bond auction isn’t easy and involves careful analysis and judgment,” says Rowan Miranda, associate vice president for finance. “Based on information provided by our consultants, however, it appears the university saved about $1.4 million to $2.2 million over the life of the bonds when compared to previous approaches.
“In instances when the structure of a bond issue is fairly straightforward, using an auction model helps the university secure the lowest possible interest rates. Our Treasurer’s Office has historically done an outstanding job when issuing bonds as demonstrated by interest rate comparisons to our higher education peers, but the auction model provides an opportunity to do even better.”
With an online auction, potential bidders are notified through advertisements, press releases and other communications that an auction will take place on a specified date for a predetermined time. The duration of the auction typically is 10 to 20 minutes. The university’s auction attracted a field of 11 prominent financial organizations, ranging from Bank of America-Merrill Lynch and CitiGroup to Goldman Sachs and J.P. Morgan. Bank of America-Merrill Lynch was the winning bidder. The university was successful in attracting far more bidders than most bond auctions because of its track record for prudent financial management, Triple A bond ratings (the highest possible), and high brand recognition in the marketplace.
“I often tell students that, while it is very important to maintain good relationships with investment banking firms, it’s hard to justify, from a financial stewardship standpoint, paying even slightly higher interest rates just to do business with a specific underwriter,” says Miranda, who also teaches public finance at the Gerald R. Ford School of Public Policy. “When you’re issuing bonds, the lower the interest rate, the better, and that’s what the university was able to get through the auction process.”
A bond is a debt instrument that allows organizations to borrow money at a defined interest rate for a specified period of time. Investors, generally individuals and institutions, buy bonds from underwriters with the understanding that they will receive principal and interest payments over the life of the bonds at regular intervals. Bonds, when issued by an organization that is fiscally sound, are a relatively risk-free investment for the investor.
Traditionally, issuers of bonds negotiate with one or more underwriters to arrive at an interest rate, but such negotiations don’t really allow underwriters to truly compete. By contrast, though, an online auction uses Web-based technology that actively promotes real-time competition between underwriters.