Our Dutch Auction Process
From day one, we’ve built our platform on transparency. Now, more than ever, we believe it will play a critical role for private credit markets.
While accurate information dissemination is vital to a well functioning market place, so is the ability for fluid price discovery and enhanced communication channels. On this premise, we introduced the Dutch auction feature for our short-term notes program.
Many of us at Percent have been through a myriad of market disruptions in the past and fully understand that volatility and price dislocations subside with certainty and conviction. We’ve built our platform on transparency to provide investors with the information they need to understand the risks and make a decision on whether the reward is sufficient according to their own risk tolerances.
We continue to provide real-time data and ongoing monitoring of all of the underlying assets supporting our notes for as many originators as possible. And while accurate information dissemination is vital to a well functioning market place, so is the ability for fluid price discovery and enhanced communication channels. On this premise, we have introduced the Dutch auction feature for our short-term notes program.
This mechanism will form part of the syndication process going forward to determine market-clearing levels with respect to the expected APYs of the offered notes.
Historically, for any given inaugural deal or rollover, we announced a static yield and target amount based on our estimations of what can be sold. Rather than estimating, we will now ask investors to indicate their demand across a range of yields so that we can build a more efficient order book and launch deals with much greater certainty of closing.
This will be done via a simple survey e-mailed to all of our investors. The survey will include each of our offerings expected to close over the following two-week period. Going forward, we will refer to the day the auction survey is delivered to investors as the Auction Day for each note.
Our syndication periods will remain the customary two weeks. However, it will now be split with an initial three-day “survey” period where we aggregate results and indications of demand at different price points. We will then communicate the Dutch auction results to our originator partners. With this information, Percent and our originators decide whether they want to announce presumably a larger deal at a higher yield or a smaller deal at a lower yield, dependent upon the survey results.
We believe the Dutch auction system will ultimately add an additional layer of transparency to our platform. By way of providing an unbiased channel of communication between originators and investors, and helping to rebalance the risk-reward equation, this feature will be a critical element in delivering greater pricing efficiencies for all market participants.
What is a Dutch Auction?
According to the Corporate Finance Institute, a Dutch auction is “a price discovery process in which the auctioneer starts with the highest asking price and lowers it until it reaches a price level where the bids received will cover the entire offer quantity.” We define it as a means by which we can identify the level of demand that exists at different price points. This enables us to see at what price, aka APY in the context of our offerings, we would be able to cover the minimum note size we are intending to issue.
For example, let’s imagine a situation where our 1-month minimum note size is $500,000 and we are trying to discover different price points from our investors. Let’s say we are providing 4 different yield options (price points): 11%, 12%, 13%, and 14% APY.
This range is initially predetermined by the APYs of recent notes we have closed on our platform, and ultimately the cost of capital that our origination partners can bear given the expected returns on their underlying asset portfolios. While rational investors always want the highest return possible for the risk they are willing to take, the originator, on the other hand, wants to minimize their cost of capital to maximize returns on the underlying assets.
Example: To keep it simple, let’s say 10 investors have answered the survey with the following indications:
As you can see, this example includes a diverse array of responses from investors. Some investors had no demand at any APY, such as Investor 9, some investors were indifferent to the varying APYs, such as Investor 2, and some investors were only interested in these notes at certain APY breaks, such as Investor 3, 4, 6 and 10.
Once we receive this information and analyze the aggregate price breaks, it is important that our originators and investors understand that we will not be providing different prices or APYs to suit different investor preferences. We will have only one final APY that will be applicable to all investors that participate in the note, and this APY is equivalent to the minimum APY required to fulfill the target note size.
In this example, for a minimum note size of $500,000 the note will require an expected 13.00% APY (and Investor 6’s indication would not be considered). If the minimum note size was $300,000, then the required APY for the note will be 12.00% (and Investor 6 and 10’s indications would not be considered). Alternatively, should the intended note size be $700,000, then the note will require an expected return of 14.00% APY (and all investors would be considered).
Our Process at Percent
As with every new feature, we are very excited for its release and aim to provide clear guidance around how investors should be leveraging it to their benefit. The Dutch Auction will consist of a six-step process.
- Our subscribed accredited investors will receive a notification via email to participate in the Dutch auction on the Auction Day for all offerings slated to close over the following two-week period
- For each offering during the auction period (generally 2-4 days), investors can indicate what amount they would like to invest for each of the specified APYs
- Percent will aggregate these non-binding indications of interest for each APY to estimate how much demand exists at each APY interval for each offering.
- At the end of the auction period, Percent will announce the offering as usual, except at the APY with expected sufficient demand to satisfy the target amount to be issued
- If the contemplated transaction is a rollover offering (following a maturity or a call), existing investors will have priority allocations
- If the transaction is not fully subscribed by existing investors or if the transaction is a new offering, only investors that participated during the auction period that provided indications at or below the announced APY will be notified of the offering launch and given priority allocations, as applicable
- Investors that do not provide an indication during the auction period will be able to participate and place an order during the deal syndication if the transaction was not fully subscribed by existing investors and/or investors who participated in the auction
Please note that the indications with the lowest yield will be reserved first up to the desired amount since the issuer will prefer to minimize their cost of capital. To this point, should the note receive enough demand at a lower yield, no bids above that yield would be taken to ensure true price discovery.
How this Helps Originators & Investors
We believe that in periods of heightened volatility, a platform that promotes the value of transparency must step up and introduce innovative concepts that push the private credit asset class forward into the mainstream. We have been discussing how and when to introduce this feature for quite some time because we believe it benefits both originators and investors alike. By providing the option to indicate and reserve allocations, we are providing investors with a direct channel to voice their risk tolerance. And with increased visibility into the bookbuilding process, originators will be better equipped to make decisions on their own portfolio and funding plans.
As broader market volatility subsides and the track records of our originators are continuously validated by consistent performance, expected returns on our notes should decrease in a fully functioning market. As we continue to bolster our efforts in providing timely and reliable data around the health of our originators and their portfolios, we decided now is the time to introduce a feature that will give investors and originators a more direct line of communication. We believe it’s a win-win. Not only are we giving our investors an even bigger voice on our platform, but we’re also making it easier than ever for our originators to hear what they’re saying.