An underwriting spread is the difference between the amount that underwriters, such as investment banks, pay an issuing company for its securities and the amount they receive from selling those securities in a public offering. Essentially, the underwriting spread represents the investment bank’s gross profit margin and is typically disclosed as a percentage or in points-per-unit-of-sale.
Key Takeaways
- The underwriting spread is the difference between the amount an underwriter pays an issuer for its securities and the proceeds from selling the securities during a public offering.
- The spread marks the underwriter’s gross profit margin, which is subsequently deducted for other costs such as marketing expenses and management fees.
- The underwriting spread can vary on a deal-by-deal basis depending on several factors, including risk and market demand.
Factors Influencing Underwriting Spread
The size of underwriting spreads is determined on an individual deal basis and is directly influenced by the underwriter’s perceived risk and expectations for market demand.
This spread depends on negotiations and competitive bidding among members of an underwriter syndicate and the issuing company itself. The spread tends to increase as the risks in the deal increase. For an initial public offering (IPO), the underwriting spread usually includes:
- The lead manager’s fee
- The underwriting fee earned by syndicate members
- The sales concession allocated to the broker-dealer marketing the shares
The value of an underwriting spread can be affected by several variables such as the size of the issue, associated risks, and market volatility.
Proportionately, the concession tends to rise as the total underwriting fees increase, while management and underwriting fees decrease with gross underwriting fees. This is generally due to differential economies of scale. Tasks like creating the prospectus and preparing the roadshow involve fixed costs for investment bankers, whereas sales work scales with the size of the deal. Larger deals might not require significantly more investment banker effort, but may involve much more sales effort, thus increasing the selling concession.
Collaboration Among Underwriter Syndicates
In some cases, junior banks join a syndicate even if they receive a smaller share of the fees as part of a lower selling concession. Junior banks have reason to join to gain experience and enhance their market credibility.
Real-World Example
To illustrate an underwriting spread, imagine a company that receives $36 per share from the underwriter for its stocks. When the underwriters sell the shares to the public at $38 per share, the underwriting spread is $2 per share.
Overall, the underwriting spread is a critical element in the revenue structure for underwriters and indicates not only the immediate gross profit but also the underlying risk and effort put into bringing a security issuance to the market.
Related Terms: IPO, underwriter syndicate, concession, broker-dealer, volatility.
