How a Reverse Auction Works
Strategery will not only purchase the worst assets available in the market, but it will do so at an inflated price. This is a technical challenge our research team has been able to solve through the use of a "reverse auction."
A regular auction has one seller and many buyers. A reverse auction has one buyer (Strategery) and many sellers (domestic and foreign banks, trusts, brokerages, etc.).
We will be buying large baskets of bad loans. Now, a loan to Joe is not exactly the same as a loan to Fred, so you might think it is impossible for banks to compete since their products are so different. You will be pleased to learn that our research department has been able to quantify many of the risk measures.
How do we do it? We make sure that the portfolios the banks are selling us all have similar geographical distributions, credit ratings, and approximate time to maturity.
Beyond that, the differences are basically random, so sometimes the banks will sell us packages that have some surprisingly good loans and sometimes they will sell us what will turn out to be less attractive packages.
After all, what are the chances that a bank will sell us a package that they know contains even worse loans than we think? That wouldn't be a very friendly thing to do.
An Example
We announce we are purchasing 20-year sub-prime mortgages in the northeast. Bank A has a package with $100 million such loans outstanding, and so does Bank B, but Bank B happens to know that most of their clients are worse off than they appear by our coarse risk measures. Bank A tries to sell us their package for 80 cents on the dollar when it is really worth 75. Without our excellent reverse auction, we would only overpay by five cents on the dollar.
But Bank B undercuts and offers their package for 74 cents on the dollar, a package which is really only worth 20 cents on the dollar. We accept their offer.
Thus, we are able to pay 54 cents on the dollar above market price instead of just 5 cents. That is the magic of the reverse auction.
