What Is Underwriting Spread?
Let me explain what an underwriting spread is. It's the difference between the dollar amount that underwriters, such as investment banks, pay an issuing company for its securities and the dollar amount that those underwriters receive from selling the securities in a public offering. This spread is essentially the investment bank's gross profit margin, and you'll typically see it disclosed as a percentage or in points per unit of sale.
Key Takeaways
You should know that the underwriting spread is the difference between what an underwriter pays an issuer for its securities and the total proceeds from selling those securities in a public offering. This spread represents the underwriter's gross profit margin, from which you deduct items like marketing costs and the manager's fee. Remember, the underwriting spread varies from deal to deal based on several factors.
Understanding Underwriting Spread
The size of these underwriting spreads gets determined on a deal-by-deal basis, mainly influenced by the underwriter's perceived risk in the deal. This risk ties into expectations for demand of the securities in the market. You can expect the spread to depend on negotiations and competitive bidding among the underwriter syndicate members and the issuing company itself. As the risks involved with the issuance go up, so does the spread.
For an initial public offering (IPO), the underwriting spread usually breaks down into components like the manager's fee earned by the lead, the underwriting fee earned by syndicate members, and the concession given to the broker-dealer marketing the shares. The manager typically takes the whole underwriting spread, while each syndicate member gets a share— not necessarily equal—of the underwriting fee and a portion of the concession. Even a broker-dealer outside the syndicate can earn a share of the concession based on their sales performance.
Keep in mind that the value of an underwriting spread can be affected by variables such as the size of the issue, risk, and volatility. Proportionately, the concession increases as total underwriting fees rise, while management and underwriting fees decrease with gross underwriting fees. This effect often comes from differential economies of scale—the work in writing the prospectus and preparing the roadshow is somewhat fixed, but sales work isn't. Larger deals don't require exponentially more investment banker effort, but they might need much more sales push, which means increasing the selling concession proportion. Sometimes junior banks join a syndicate even if they get a smaller fee share through a lower selling concession.
Example of an Underwriting Spread
To give you a clear picture, consider a company that receives $36 per share from the underwriter for its shares. If the underwriters then sell the stock to the public at $38 per share, the underwriting spread would be $2 per share.
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