What it means
When a company or a government issues new securities, an investment bank usually leads a group of banks, called a syndicate, that buys the issue and resells it to investors. The group earns a gross spread, which is the difference between what the issuer receives and what investors pay.
That spread is split into a management fee, an underwriting fee and a selling concession. The selling concession is the portion paid to the firm that actually sells the securities.
If a selling firm uses another dealer who is not part of the syndicate to find buyers, it may pass on part of its concession. That passed-on part is the reallowance.
It is usually quoted per unit, such as dollars per $1,000 bond or cents per share. The syndicate sets it in advance, and the terms are described in the offering documents.
A larger reallowance encourages more dealers to promote the issue, which can speed up the sale. For the issuer, the reallowance is a cost built into the overall spread, so it ultimately affects how much money the issuer raises.
For the dealers, it is revenue that rewards effort. Investors never see it directly, although it is part of the price they pay.
Reallowances are most often discussed in municipal bond and corporate bond offerings. The amounts are modest, often a few dollars per $1,000 of bonds, but on large issues they add up.
Rules from regulators govern how they may be paid and disclosed. When reading an offering document, it helps to find the line that shows the concession and reallowance per unit.
Comparing them across similar issues shows whether the syndicate is paying a high price for distribution. A very large reallowance can signal that the issue is hard to sell.
In practice
Real-world examples.
Example
A syndicate led by a large bank sells a $100,000,000 bond issue for a city government. A regional dealer outside the syndicate finds buyers for $3,000,000 of the bonds. The syndicate pays the dealer a reallowance of $4 per bond, or $12,000 in total.
Example
A company issuing shares in an offering sets the selling concession at 60 cents per share and the reallowance at 25 cents. A small broker placing 200,000 shares with its clients earns 200,000 x 0.25 = $50,000. The issuer sees this as part of the underwriting cost.
Example
A finance analyst reviewing a bond prospectus notices that the reallowance equals almost half of the selling concession. She concludes that the syndicate expects heavy use of outside dealers. She includes this in her estimate of the total cost of the issue.
Formula
Calculation
Reallowance paid = Number of units sold through the dealer x Reallowance per unit
Suppose a bond offering has a selling concession of $9 per $1,000 bond, and the syndicate sets the reallowance at $4 per bond. A selling firm places $5,000,000 of bonds, or 5,000 bonds, through a non-syndicate dealer. The reallowance paid is 5,000 x 4 = $20,000. The selling firm keeps the rest of the concession, which is (9 - 4) x 5,000 = $25,000.Case study
Seen in the real world.
Pelican Harbour Authority is an illustrative, fictional port operator issuing $40,000,000 of bonds. Its lead bank proposes a gross spread of $12 per $1,000 bond, made up of $3 of management fee, $2 of underwriting fee and $7 of selling concession.
To reach more buyers, the lead bank sets a reallowance of $3 per bond for dealers outside the group. Outside dealers sell 10,000 of the 40,000 bonds, so the reallowances total 10,000 x 3 = $30,000.
The authority's finance director checks that the total spread is in line with similar issues and notes that the reallowance is part of the $480,000 total cost. In this illustrative case, the wider distribution helps the bonds sell out within a day, which she judges worth the cost. She records the reallowance as part of the issue costs, which are spread over the life of the bonds in the accounts.
Watch out
Common mistakes.
- Confusing the reallowance with the whole selling concession, when it is only the part passed to another dealer.
- Assuming the reallowance is an extra charge on top of the spread, when it is paid out of the concession.
- Thinking investors pay it separately, when it is built into the offering price.
Questions
People also ask.
Who sets the reallowance?
The lead underwriter or syndicate sets it in advance, and it is described in the offering documents.
Is a reallowance the same as a commission?
It is similar in purpose, as both reward selling, but a reallowance is specific to underwritten offerings and is paid between dealers. A commission, by contrast, is usually charged to a client for executing an order.
Does the reallowance affect what the issuer receives?
Indirectly, yes, because the issuer receives the offering price less the whole spread, of which the reallowance is a part.
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