What Could Axelrod do with a bank?
If you followed season 5 of billions, you know that Axelrod is becoming obsessed with
being a bank.
Chuck Rhoades won’t let him, of course.
Based on a Wall Street Journal article, it looks like hedge funds dream of that a lot
but it never happens in the real world.
(“it’s not unusual for a rich hedgie to want to buy a bank, but one conversation with
a lawyer usually squashes the dream.
About 10 minutes after they get that idea, they realise it won’t work.
The regulators won’t let you do that.”
WSJ)
But that won’t stop Axelrod from trying.
or me from doing an analysis!
What I want to know is: what does it mean to be a bank for axe?
And is it really a good idea?
Clever comments said it’s a private equity play.
In that case, the bank would be part of a portfolio.
The goal is to restructure it and sell it back at a profit.
An excellent idea but I don’t think that’s the intent here.
Axelrod wants to operate a bank - while still being a hedge fund manager.
We know he wants a community bank, ideally in his hometown of Yonkers.
In the beginning, he’s applying for a bank charter, so he wants to build a bank, but
he quickly realises it’s easier to buy one.
There’s a scene where he tries to buy Marcus from the actual CEO of Goldman Sachs.
There are over 4000 community banks in the US.
Many are listed.
If you are a billionaire you should be able to snap one.
[find a bank to buy: feasibility 100%]
We’re looking at some kind of merger between axe capital, the hedge fund, and a community
bank.
Banks are very regulated.
I don’t think they’d be able to have a hedge fund with a bank on top.
The bank would have to remain a bank.
There would be two entities in the group: Axe Capital Fund - Axe bank (a square)
So to be a bank actually means to own it and operate it as a standalone entity.
Let’s jump ahead and assume that Axe has won.
And he’s bought himself a bank.
I picked the first listed US community bank alphabetically: 1st Source Bank.
We have a price tag for it: $1.08b.
Maybe they could buy it for a premium let’s just say 20% or $1.3b.
That feels about the right price for a fund like Axe Cap.
Let’s rename it Source Bank, because we’re going to use it as a source for boosting the
hedge fund.
He’s a banker now.
To see if that was a smart move: We’re going to use the bank as much as we can.
We’re looking at the upside potential and the downside protection.
the downside protection?
Banks being safer and protected was the main thing for Axelrod he wants an easier life,
where he can relax and have dinner with his family, a different world
(where the govt …)
Now that the Axe group owns a bank, does he have government protection if things go wrong
at the bank or at the fund?
If that’s the case he should maximize the risk.
If it works great, if not he gets bailed out.
And it’s like nothing happened?
Back to the hedge fund life.
Wags liked the idea (quote).
This is where the separation between the two businesses matters.
Let’s say the bank collapses.
(drop) The government intervenes.
The deposits are insured.
In practice, they’d bring in some other bank to take over the deposits.
And they’d wipe out the equity.
Axelrod paid $1.3bn.
And the hedge fund would really be in the eye of the regulator.
There is no way that owning a bank could provide a
safe cushion for axe capital as a group.
[feasibility: 0%] Axe’s dream was based on a misunderstanding
of the banking regulation.
No downside protection but Let’s look at the upside
We’re assuming they are allowed to merge, but they’d still need to comply with the
rules.
And when it comes to banks, there are a lot of rules and regulations.
Selling to the bank’s customers Banks have customers that are somehow captive.
They have deposits and loans, but the bank can sell other products too.
Could Axe Capital sell stuff to them?
No, at least not straight away.
There’s the Dodd-Frank Act of 2010 (introduced new rules to protect consumers after the Great
Financial Crisis.)
And Reg D (is a 1933 SEC regulation that limits what hedge funds and others can do to raise
capital.)
That prevent selling complex financial products to regular folks unless they are accredited
investors.
However, I think Axe Cap could create and package strategies as funds or ETFs, those
wrappers would allow them to be shipped through the bank.
Man Group, Marshall Wace are some famous hedge fund managers that took this route.
It was a moderate success.
Marshall Wace’s ETF was launched in 2010 and is still alive today but it has only about
200m in assets.
The Man GLG ETF was liquidated after a few years.
It doesn’t look like a massive opportunity.
[feasibility: 50%; Impact: 20%] Now wouldn’t it be nice if the bank could
invest its balance sheet in the funds managed by axe capital?
A bank’s balance sheet is different from a regular company.
￼
There are always investments or trading assets because banks can invest their deposits.
The investments are generally very conservative.
Could we invest in a risky hedge fund?
There is the Volcker Rule from 2013, which followed the Dodd-Frank act.
It Prevents banks from getting involved with any hedge fund stuff or risky investments.
Or I should say Prevented (The Volcker rule generally prohibits banking
entities from engaging in proprietary trading and from acquiring or retaining ownership
interests in, sponsoring, or having certain relationships with a hedge fund or private
equity fund.)
There’s good news for axe capital!
In June 2020, it was amended by the Trump administration.
Now a community bank can invest in hedge funds as long as it has less than $10bn in assets.
(As a result, an insured institution is not subject to the Volcker Rule regulations if
it has $10 billion or less in total consolidated assets
and total consolidated trading assets and liabilities of 5% or less of total consolidated
assets)
1st source has $7.5 bn So they could invest in Axe Capital
But based on the same legislation it can only be up to 5% of the total assets: $375M
These are funds that he will control so unlike other clients that can leave, they are here
to stay.
There may be more rules that I am missing but it looks doable, the amount and impact
are not huge.
It’s looking good
[feasibility: 80%; Impact: 30%] Now let’s see if the bank could lend cheaply
to the hedge fund.
There are other restrictions on what the bank can do with its balance sheet.
The banking rules have been set at the Basel Accord.
One critical aspect is the capital adequacy ratio.
The limit is defined as a percentage of its equity.
Under basel 3, it is 8% The formula is:
Tier 1 capital ratio = (Core Capital) / (Risk-Weighting x Risky assets)
Source Bank risk weighted assets are at about 6 billion and its tier1 capital ratio is at
15.3 Its Tier 1 Capital is 915million
I calculated that I can have a total of 10.5billion in risk weighted assets, so 4.5
more The risk weighting for lending to a hedge
fund would be at 150% So I could lend 3billion more
I couldn’t find a rule about the debt limit but there are a few things to consider
Reserve requirements The amount of funds that a bank holds in reserve
to ensure that it is able to meet liabilities But they’ve been set to 0% in the US in
March 2020
There’s also the leverage ratio but it looks less constraining than the tier 1 capital
ratio
And this is where I discovered the magic of banking:
When a bank makes a loan, there are two corresponding entries that are made on its balance sheet,
one on the assets side and one on the liabilities side.
The loan counts as an asset to the bank and it is simultaneously offset by a newly created
deposit, which is a liability of the bank to the depositor holder.
Loans create deposits.
Banks create money!
There are more interesting ratios in the Basel Accord and there could be more rules.
Actually that would bring us above the $10bn threshold for being able to invest directly.
So what i am going to do is just lend $2.4b.
The assets are now $9.9bn.
I can invest 5% in hedge fund assets as per the new Volcker rule - that’s $500 million
I’m going to lend the rest of $2.4 billion- 05.m = $1.9bn
That actually covers the cost of buying the bank.
I’m going to lend it to the hedge fund at 0% or something very low,
For Axe the banker
And it has investments in a hedge fund.
So as long as the investment performs, we are good!
Again there may be more rules.
overall I’d say 50% doable, and the impact is positive.
Where does that leave us?
Overall [conclusion]: I have a confession to make.
I thought that the bank thing in Billions was completely bogus at first, it was never
going to happen.
A bit like a mcguffin in the Hitchcock movie, something that’s important for the character
but the plot is about something else.
Now based on this analysis, there is some upside, but Axe’s dream of being protected
is not going to happen.
So that brings me to the next question: Is there a better option for a hedge fund?
The answer is yes - we’ll find out in the next episode, and we’re getting some tips
from this guy.
So what do you think?
Did I miss out on any regulation?
Or is there any loophole that would allow Axe to really benefit from a bank?
Let me know in the comments!
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