The credit bid priced against the lender's REO plan, the guarantee on the deficiency and tax on the bid, with the outcome for every rival bid.
Credit bid what the property is worth to you as an owner, not the debt and not a token amount. On an illustrative 42,500,000 claim against a building the lender would value at 28,134,000 as REO, bidding that figure guarantees at least 31,058,389 once the guarantee on the deficiency is counted. Bidding the full claim gives 27,709,092 in every case; a low bid of 24,000,000 gives 32,022,191 if nobody else bids, but only 28,128,099 if someone does.
Worked in full in The Real Estate Workout by Julian R. Sterling, with every figure reproduced in a free workbook.See the book on Amazon →
A credit bid lets the foreclosing lender bid its own debt instead of cash. It feels free, which is why it is so often set badly: either at the full claim, to make sure the lender gets the building, or at a nominal figure, to preserve the largest deficiency. Both settings cost money. The right figure follows from three things: what the building is worth in the lender's hands, what a dollar of deficiency is worth against the guarantor, and what it costs to bid more, such as transfer tax charged on the bid. Rules on credit bids, deficiencies and taxes differ by jurisdiction; the arithmetic below is illustrative.
| Input | Value |
|---|---|
| Principal | 40,000,000 |
| Accrued interest, default interest and costs | 2,500,000 |
| Appraised as-is value | 29,000,000 |
| Capex and net carry if the lender owns it, over 12 months | 1,500,000 + 600,000 |
| Sale after stabilisation, in 12 months, less 2.5% costs | 34,000,000 |
| Lender's required return as an owner | 10.0% |
| Transfer tax charged on the bid | 1.0% |
| Guarantor: share of deficiency collected, after 2 years, less 10% costs | 30% |
Step 1: the claim. 40,000,000 + 2,500,000 = 42,500,000, the most the lender can credit bid.
Step 2: what the building is worth to the lender. Price the REO plan, not the appraisal, at an owner's return.
Net sale = 34,000,000 × (1 − 2.5%) = 33,150,000; PV = 33,150,000 ÷ 1.10 = 30,136,364
PV of capex and carry, mid-year = 2,100,000 ÷ 1.100.5 = 2,002,271
REO value R = 30,136,364 − 2,002,271 = 28,134,092, 66.2% of the claim and 97.0% of the appraisal
Step 3: what a unit of deficiency is worth. Every dollar not covered by the bid remains a claim against the guarantor, where the jurisdiction measures the deficiency from the sale price.
Value per 1 of deficiency = 30% × 1.10−2 (0.8264) × (1 − 10%) = 0.2231
Step 4: the lender's value for any bid B.
If no one outbids: R − tax × B + 0.2231 × (claim − B)
If a third party outbids: it pays about B in cash, so B + 0.2231 × (claim − B)
Above R, every extra dollar of bid costs the lender 0.2331: a cent of tax and 22 cents of guarantee, for no change in what it owns. Below R, every dollar of bid saved is worth the same amount, but only if no one else bids; if someone does, the lender sells a building worth R for less than R.
| Credit bid | No other bidder | Rival bids 26.0m | Rival bids 28.5m | Rival bids 31.0m |
|---|---|---|---|---|
| Low bid, 24,000,000 | 32,022,191 | 28,128,099 | 28,128,099 | 28,128,099 |
| REO value, 28,134,000 | 31,058,389 | 31,058,389 | 31,339,636 | 31,339,636 |
| Appraisal, 29,000,000 | 30,856,489 | 30,856,489 | 30,856,489 | 32,012,397 |
| Full claim, 42,500,000 | 27,709,092 | 27,709,092 | 27,709,092 | 27,709,092 |
Bidding the REO value is the robust choice: its worst outcome, 31,058,389, is the best worst case on the table, and the lender is close to indifferent between winning and being outbid, which is the definition of a well-set reserve. The full credit bid is the worst choice in every column. Against bidding R, it throws away 3,205,636 of guarantee value and pays 143,660 more tax (425,000 against 281,340), 3,349,296 in all, to win a building worth no more than 28,134,092 to the lender.
The low bid is a wager that nobody else turns up. If that is near certain, because the asset is distressed and the sale is thinly marketed, it adds 963,803 of value. If a buyer appears with 26,000,000, the lender receives 24,000,000 for a building worth 28,134,092 to it.
In jurisdictions that limit the deficiency to the claim less the fair value of the property, whatever the bid, a low bid preserves no extra claim. With fair value at the 29,000,000 appraisal, the deficiency is 13,500,000 for any bid below it, and the low bid's only remaining advantage is a little tax: 30,906,489 against 30,865,149 for bidding R. It still carries the full risk of being outbid cheaply, so bidding R becomes the clear answer.
Treating the credit bid as costless and bidding the claim. It feels conservative, because the lender is sure to get the building, but it extinguishes the deficiency, raises any tax charged on the bid, and buys nothing: a bid of 28,134,000 would also have won against every rival below that figure. The opposite mistake is the nominal bid set to maximise the deficiency, which hands the building to the first buyer willing to pay a little more. In both cases the lender has not priced its own alternative. The same discipline applies to choosing the route in the first place, as in deed in lieu vs foreclosure.
The book prices enforcement as the alternative every other option is measured against; the free workbooks for the case break enforcement into the forced-sale discount, the delay, the costs and the carry. What a guarantee is worth once solvency and time are applied is worked in how much a personal guarantee is worth.
Because it extinguishes the deficiency claim and can raise any transfer tax charged on the bid, without changing what the lender owns. In the example a full 42,500,000 credit bid is worth 27,709,092 to the lender against 31,058,389 for bidding the REO value of 28,134,000, a cost of 3,349,296.
The third party buys the property and pays cash roughly equal to the lender's bid, and the lender keeps a deficiency claim for the rest. If the credit bid equals the property's value to the lender, being outbid costs nothing: in the example the lender receives 31,339,636 including the guarantee value, slightly more than if it had won.
Only where the deficiency is measured from the sale price. Where it is limited to the claim less the property's fair value, a bid below fair value preserves no extra claim. With fair value at 29,000,000 the deficiency is 13,500,000 for any lower bid, and the low bid keeps only its risk of being outbid cheaply.
This article is one calculation from The Real Estate Workout. The book takes the same case from first principles to the decision, chapter by chapter, and every figure it prints is a live formula in the free companion workbooks.
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