Capital Requirements for a Municipal Underwriter
Municipal bonds are securities which help government entities to afford social programs and assets that benefit the public. In order to bring them to market, governments make use of a municipal underwriter, also referred to as a municipal dealer. The municipal underwriter must adhere to the same standards as other broker-dealers, including those of the Securities and Exchange Commission (SEC). He must also follow the rules and regulations set forth by the Municipal Securities Rulemaking Board (MSRB).
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SEC Requirements
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There are two methods by which a municipal underwriter can determine how much capital the SEC requires his business to have. These are the basic, or aggregate indebtedness method and the alternative method. Most smaller dealers use the basic method, especially during their first year of business. These net capital requirements ensure that the underwriter maintains enough liquidity to satisfy any claims of his clients.
Basic Method
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The basic method requires that the municipal underwriter have a minimum of $250,000 or 6 2/3 percent of the company's aggregate indebtedness on hand, whichever is greater. This means that the dealer must carry $1 for every $15 of indebtedness. However, if the municipal underwriter does not carry any customer accounts, but merely sells the bonds, the SEC limits the requirement to $100,000 or 6 2/3 percent, whichever is greater. Indebtedness is the amount that the underwriter owes to others, including lenders and customers purchasing municipal securities. However, in the first year of business, the dealer must meet the capital requirement of 12.5 percent of its total indebtedness. The basic method also requires that the dealer have a bad-debt reserve of 1 percent of all customer-related receivables.
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Alternative Method
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The alternative method is most often used by larger broker-dealers because it can require less capital. This method requires that the underwriter carry a minimum of $250,000 or 2 percent of all customer-related receivables, whichever is greater, and ensures that the dealer is in a position to return the clients' capital if necessary. The alternative method also requires that the municipal underwriter have a bad-debt reserve of 3 percent or all customer-related receivables.
Underwriting Assessments
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For any new issues of municipal securities except municipal funds, the underwriting manager must pay the MSRB a fee of 0.003 percent of the par value of all of the securities. This constitutes $.03 for every $1,000 of bonds that the dealer issues. Therefore, if the underwriter purchases $500,000 in bonds that he plans to issue to the public for sale, he must pay a fee of $1,500.
Transaction and Technology Fees
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The municipal securities dealer incurs a fee for each transaction in which he sells his bonds to another dealer or the public using a system called the Real-time Transaction Reporting System. Municipal dealers are required to use this system because it allows for more accurate pricing of bonds. The transaction fee is 0.001 percent of the total par value of the bonds, payable to the MSRB. For example, if the dealer sells $500,000 of municipal bonds to the public or another dealer, he must pay the MSRB a total of $500. The technology fee is $1.00 per transaction. Most municipal dealers sell large numbers of bonds in a transaction.
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