FINANCIAL MANAGEMENT/City fares well with online bond sales

In July 1999, New Haven became the first city in Connecticut to delve into the realm of online bond sales when it used the Internet to sell $48 million of bond anticipation notes to begin school construction and other projects. At the time, the transaction was the largest such sale – conducted nationally and using electronic bidding.

By putting the bidding process online, the city was able to attract bidders that it otherwise would not reach. In fact, the winning bid for the July 1999 issue came from an underwriter that had never before bid on New Haven’s debt.

Available to state and local governments, electronic bidding allows issuers to open bidding for bonds and notes online. As a replacement for or supplement to traditional bidding practices (e.g., bidding via telephone, in person or in writing), the electronic format eliminates geographic barriers and broadens demand for the issuer’s debt. It allows any underwriter in the country to bid (typically at low or no cost), and the increased demand reduces the issuer’s interest costs. (For the July 1999 notes, New Haven’s interest rate was 3.48 percent.)

Local governments are recognizing the advantages of electronic bidding, and several online vendors are now vying to provide the related services. For example, New Haven has used Pittsburgh-based MuniAuction, and the market has expanded to include competitors such as Bloomberg, based in Princeton, N.J., and Parity, based in New York.

In addition to broadening the pool of potential buyers and enhancing competition, the online bidding process has many advantages. For example:

– Built-in checks ensure that bids meet the set parameters;

– Investor participation is direct;

– Analysis and ranking are instant; and

– Data can be downloaded to a bid verification model.

Of course, there are risks associated with electronic sales. For example, the electronic medium (e.g., the Internet or wireline network) could fail, although the risk of wholesale failure is mitigated largely by the nature and design of the Internet. Additionally, the issuer’s/bidder’s server could fail, or bottlenecking could occur.

Security breaches and user error also are risks. Steps must be taken to prevent the illegal capture of data prior to bid time, and data should be encrypted for proprietary use only. There will likely be some user error as there is with any new process, but the risk is particularly heightened when bid data is being transferred from one medium to another.

For New Haven, online bidding has been relatively trouble-free. For one bond issue, two bids arrived after the bidding period had closed, but that sort of problem is a technological bump in the road, which should diminish as electronic bidding becomes more commonplace.

Since its first experience with electronic bidding, New Haven has conducted two more online bond sales. Early this year, a $55 million bond issue attracted eight bids – an all-time high for New Haven – and a smaller issue soon afterward attracted four bids and a competitive interest rate for the city.

Over the next few years, electronic auctions may become the predominant means by which municipal securities are purchased in the primary market – at least for competitive transactions. The process can streamline bidding while broadening competition, and, as demonstrated in New Haven, it can expand a city’s presence in the national municipal bond market. As a result, online bidding and sales have taken their place among New Haven’s successful financial management initiatives.