Phil Bird, CEO of Perfect Channel believes that Governments and most major financial institutions could significantly improve their returns when they sell off secondary market assets.
The UK Government has just sold off nearly £900 million of student loans to a debt management consortium, which secured the portfolio of ageing loans with a bid of just £160m. Chancellor George Osborne has announced that the revenue has already been ear marked to fund an additional 30,000 university places next year.
But in all the headlines and political hype, the big question left unanswered is ‘could the Government have secured a better value at sale’? And just like any financial institution, selling off a secondary market product, from mortgage books to ageing loans, it has to ask itself if this really represents ‘good value for money’? I believe that using the most advanced auction technology, a number of key factors could have significantly improved the Government’s return, netting more money for the public purse.
The student loan book is essentially a portfolio of illiquid assets, with a deteriorating value, becoming harder to collect over time. A key characteristic of each student loan is the choice of college and type of degree. It’s all about employability, so one factor to take into consideration is that a student graduating from an IT course, is likely to have an increased chance of paying back the loan compared to a Liberal Arts graduate. Each loan can be graded and categorised in terms of risk, just like any other illiquid asset.
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Selling a large portfolio of financial products ‘in bulk’ is always going to be discounted over a segmented portfolio. And since student loans not homogenous, but a portfolio of different loans, with differing values, an optimum return was not going to be achieved with this type of ‘bulk sale’. Splitting a portfolio of this kind is essential to deliver a maximum return, but clearly the higher the number of parties involved, the higher the risk.
The Government may have had less appetite for the potential down side of an increase in buyers – higher deal risk and deal costs. But opening up the market, reducing portfolio size, segmenting financial products, allowing bidders to self-select, are all strategies that will incite competition and ultimately deliver better value on the sale of an illiquid asset.
The sophistication of the most current auction technology available means that the auction can be designed and tailored to meet the seller’s very specific requirements, featuring complex algorithms, analysing the real value to the seller of each bid and ranking bidders accordingly, to deliver the absolute optimum number of winning bids.
Generating a Fair Market Value
Illiquid assets are among the hardest financial products to price and forming a view of their ‘fair value’ is a complex process. A Fair Market Value auction model has been developed and is ideal for this type of sale, demonstrating the ability to return a much higher yield.
Instead of creating multiple lots, the auctioneer sets up one, single lot for the whole auction, with a total value based on the sum of the worth of all the products being sold. Bidders can then choose their own portfolio of products within the auction and this is assigned a Fixed Portfolio Value, based on the proportion of the overall lot they have selected.
The auctioneer then assigns each customer a Fair Market Value. This is set as a % of their Fixed Portfolio Value. As bidding starts, and each buyer bids on their own portfolio, the system ranks bidders according to their Fair Market Value. The larger the portfolio, the greater the Fair Market Value and the more the bidder will be favoured by the auction.
Once the set time for each round of bidding is complete, the system allows bidders to view their rank and the bid of their next highest ranking bidder. The lead bidder can see that they are in the lead and the next lowest ranking bidder. In subsequent rounds bidders must either equal or outbid the next highest bidder and the lead bidder can stick or choose to bid higher, to secure their position. The auction process closes when no further bids are taken.
This approach is not only more attractive to buyers, allowing them the freedom to ‘self-select’, but consistently achieves a better overall value for the auction portfolio. It is an ideal approach in any market where the bulk product is divisible and the products have a varying perceived value.
Complex mathematical analysis and algorithms aside, the fact is, we offer a mechanism which enables true pricing and unbiased execution for bidders with different budgets, risk appetites and requirements. And I believe that it is in the interests of the Government and indeed every major financial institution, to identify the right sale mechanism, to increase utility, ensure transparency, demonstrate compliance and above all, present an even playing field for all interested parties.