What Is a Competitive Bid Option?
A competitive bid option is a form of loan syndication in which members of a group of banks submit rival offers to fund a loan.
- A competitive bid option is a form of loan syndication in which lenders within a group submit rival offers to fund a loan or debt.
- After that bidding process has established the best rate (or best price), other members of the syndicate have the option to match it or abstain from the deal; those who match will divvy up the loan amongst them.
- Competitive bid options give borrowers—usually companies or municipalities—a range of choices in lenders and rates.
- For the banks, the benefit of the competitive bid option is that it allows them the opportunity to offer loans, but without the commitment.
Understanding Competitive Bid Options
Loan syndication is the process of involving a group of lenders in funding various portions of a loan for a single borrower. In a competitive bid option, the arrangement has a slight twist: The banks in the group submit varying offers on a loan in order to win the deal, somewhat like in an auction. Each participating bank can service that loan or opt to sell their portion of the participation in that loan to other parties.
The borrower thus has a choice of banks to choose from, and will generally pick the lender with the lowest interest rates and/or fees. In most cases, the leading bank in the syndicate allocates the majority of the actual loan balance to other lenders and only keeps a small percentage of the loan for itself. The option part of the competitive bidding process refers to the fact that non-lead syndicate members can choose to match the best rate or price, or else choose to abstain.
Competitive bid options are usually priced at just above the lender's cost of funds, or above an index such as the London Interbank Offered Rate (LIBOR).
Benefits of Competitive Bid Options
A competitive bid option allows for a borrower to have banks compete to offer the lowest interest rate. After that bidding process has established a best rate (or best price), other members of the bidding syndicate have the option to match it or abstain from the deal. For those who match, the lead bank in the syndicate will divvy up the loan amongst them.
For the bidding banks, the benefit of the competitive bid option is that it allows them the opportunity to offer loans, but without the commitment—the same way a stock option gives an investor the right, but not the obligation, to buy or sell the equities at a given price. If a bank has plenty of capital, it can make a bid, but if it is experiencing lean times, it has no obligation to match the best bid and can hold off until its financial condition improves, or for the syndicate to offer higher rates.
Loan syndication in general offers several benefits. The two main ones are that it allows banks and other lenders to:
- Diversify their lending to broader demographic regions.
- Participate in larger loans (and to bigger clients) that they might not be able to finance completely by themselves.
Loan syndication is often used in corporate financing—funding large capital enterprises that companies undertake. The competitive bid option in particular commonly occurs in the municipal bond market. Borrowers are cities, states, or municipalities seeking to raise money for public projects and works. The loans take the form of municipal bonds that the banks are underwriting.
With the advent of internet banking and online financial services, individual borrowers can now also benefit from a process similar to the competitive bid option, in which lenders offer quotes for loans, and can have the option to match the best offer.
This retail version of the process is most common in real-estate-related financing instruments, such as mortgages or home equity lines of credit (HELOC), as well as for auto loans. Here, borrowers not only see who has the best interest rates but also the best total annual percentage yield (APY), after fees have been accounted for.