Auction process may deny bondholders best prices, report says
A new study of non-performing commercial real estate loan sales suggests sealed bid auctions result in prices 10-20% higher than the other main sales method. Furthermore, as use of sealed bids is rare in CMBS loan sales, bondholders maybe losing out.
Sealed bid v English forward auctions for non-performing CRE loans: a study in maximising proceeds, by loan sale adviser DebtX, compares results since 2010 for sales of secondary commercial real estate whole loans sold by sealed bid or the method known as English forward (or open ascending) auction format (see panel).
Having used both, DebtX currently favours sealed bids. Its study – based on its own data, two Fitch Ratings studies of CMBS loan sales recoveries and data from the US FDIC – found that distribution of bids on non-performing loans sold by sealed bids it has conducted, measured by the gap between highest and cover (or second place) bid over the past eight quarters, ranges from a minimum 5.1% to a maximum 9.4%.
As the average non-performing property loan sells for around 50%, this equates to an increase in proceeds of about 10-19%. “These figures not only represent the average premium of the outlier [highest] bid, but also the approximate theoretical amount by which proceeds would be reduced if the assets were instead offered in an English forward auction format,” the study says.
DebtX argues this must be so, based on an analysis of bidders’ behaviour. In today’s market, where non-performing loan buyers’ views on an asset’s value vary, sealed bidding is very likely to produce an outlier bid by what DebtX calls “a bid-to-win type” (either a sophisticated bidder with extensive local knowledge, or a chancer). This will be higher than most bids DebtX terms “rational”– ie returns-driven, disciplined and thoughtful.
But in a more transparent auction, where bidders know the bidding level, bid-to-win bids will be suppressed to only slightly more than the next highest rational bidder. DebtX also says that the main users of English forward auctions “are CMBS loan servicers that don’t necessarily have a direct economic interest in the outcome of a sale”.
Bondholders, the economic owners, “are not easily able to value fractional interests in whole loans and are not in a position to protect their economic interests by bidding on them”, the study says. They may not be in a strong position to control sales costs and market protocol is for advisers to charge “a 5% buyers’ premium” for auctions.
Servicers, meanwhile, usually have access to the best information on every asset and “many are related to entities active in purchasing loans in the secondary market”. International director Gifford West said DebtX is building a business in Europe, where it expects smaller non-performing loan portfolio and single-loan sales to pick up.
Sealed bids v English forward auctions
There are two types of sealed bids: firm and indicative/final. In the firm category, bidders receive due diligence data and are required to submit a binding bid on a certain date, without knowing other parties’ bids.
The indicative/final structure has multiple bidding rounds, the first being non-binding on bidders. One or more are asked to bid in a second, typically final round. Again, bidders do not know parties’ bidding levels.
With English forward auctions, prospective bidders review due diligence data before submitting a firm, binding bid on a set date.
However, all bidders know the highest bid at every point in the sale and the auctioneer steadily raises the bids, with bidders dropping out as the price rises. The last bidder is the highest bidder.