What is a Lead Bank?
In the securities industry a lead bank is a company, usually an investment bank, that helps companies introduce their new securities into the market by leading a syndicate of investment banks to issue the securities.
How Does a Lead Bank Work?
When a company decides it wants to issue stock, bonds, or other publicly traded securities, it hires an underwriter to manage what is a long and sometimes complicated process.
After determining the offering structure, the lead bank usually assembles what is called a syndicate to get help managing the minutiae (and risk) of particularly large offerings. A syndicate is a group of other investment banks and brokerage firms that commit to sell a certain percentage of the offering (this is called a guaranteed offering because the underwriters agree to pay the issuer for 100% of the shares, even if they can’t sell them all). The lead bank is the underwriter that has the responsibility for assembling and managing the syndicate throughout the process, which means it is primarily responsible for assembling the 'sales force' that will sell the securities.
After the syndicate is assembled, the lead bank usually writes and files an SEC Form S-1, which is also called a prospectus. Prospectus in hand, the lead bank then sets to selling the securities. This usually involves a road show, which is a series of presentations made by the underwriter and the issuer’s CEO and CFO to institutions (pension plans, mutual fund managers, etc.) across the country. The presentation gives potential buyers the chance to ask questions of the management team. If the buyers like the offering, they make a non-binding commitment to purchase, called a subscription. Because there may not be a firm offering price at the time, purchasers usually subscribe for a certain number of shares. This process lets the lead underwriter gauge the demand for the offering (called “indications of interest”) and determine whether the contemplated price is fair.
Determining the final offering price is one of the lead bank’s biggest responsibilities for two reasons. First, the price determines the size of the proceeds to the issuer. Second, it determines how easily the underwriter can sell the securities to buyers. Thus, the issuer and the lead bank work closely together to determine the price.
Once the syndicate is sure it will sell all of the shares in the offering, it closes the offering. The syndicate purchases all the shares from the company (if the offering is a guaranteed offering), with the lead bank typically buying the largest portion. The issuer receives the proceeds minus the underwriting fees. The underwriters then sell the shares to the subscribers at the offering price.
Although the underwriters influence the initial price of the securities, once the subscribers begin selling, the free-market forces of supply and demand dictate the price. The lead bank usually maintains a secondary market in the securities they issue, which means they agree to purchase or sell securities out of their own inventories in order to keep the price of the securities from swinging wildly.
Why Does a Lead Bank Matter?
Lead banks grease the skids for bringing securities to market. Issuers compensate them for this by paying a spread, which is the difference between what the issuer receives per share and what the underwriter sells the shares to the subscribers for. For example, if XYZ Company shares had a public offering price of $10 per share, XYZ Company might only receive $9 per share if the underwriter takes a $1-per-share fee (the lead underwriter shares this with the syndicate but gets a larger portion of that $1). Making a market in the securities also generates commission revenue for underwriters.
As we mentioned earlier, underwriters take on considerable risk, and the lead banks especially so. Not only must they advise a client about matters large and small throughout the process, they relieve the issuer of the risk of trying to sell all the shares at the offer price.
