Sunday, 20 March 2011


A bank can trade at a premium to NAV, why?

because it can do things that as an investor you really can't; underwriting, m&a advice, borrow from the discount window, get bailed out, etc.

Imagine a bank, but without those pesky staff eating up costs, or costly office space, or the headache of having branches. Being a shareholder would be great, you'd be the one getting the bonus!

This was Tetragon Financial Group's pitch when they were listing this vehicle in 2007. The Raven was more than a little surprised that the bankers' could keep a straight face and although being on quite good terms with the chap at DB pitching this idea, he couldn't stop himself from laughing and hanging up when it was suggested that this should list at 1.3x book, "after all banks trade at a premium to that".

There were several features that made the TFG structure appealing at that time, however it was the funding that stood out; they highlighted that they had good terms to secure locked up funding from a couple of banks.. "evergreen loans" or something equally twee.

What really stank however was the idea that historical default and recovery rates were appropriate for the underlying paper, exactly the same argument as subprime, the banks making these loans and selling them were holding little interest in them, so clearly they would be of a worse quality than they had been when they were left holding the paper, for sure they weren't going to be better! The idea that the loans would be of a superior quality because they weren't making them for a relationship was utter drivel, the bank was still making them, and taking an investment banking fee, except now they didn't have to hold them.

The real sticking point is valuation. With a bank, they can grow their assets and revenue streams, they can provide services and run a business and as an equity holder that is your business, however much the folks on Goldman's renumeration committee think otherwise.

With TFG you don't have that, sure your assets can compound, but none of the growth in the business is yours, that all goes to the managers, who get paid as asset managers with a fixed contract that as a shareholder would be very hard for you to terminate. So in reality you're just an investor in a fund, except you're a permanent investor, you're signing up to paying those management and performance fees forever!!

One would have thought that the issue and frustration of gating would have made investors more cautious, especially to the idea of locking yourself into a credit fund.

So where should this trade to relative to NAV?

Well nobody should pay a premium to buy assets in a vehicle.

But we can see that you are contracted in to pay 1.5% management fee, and 25% performance fee above libor+2.25%. That 1.5% is guaranteed, so take it off as an annuity; that's 35% thank you very much. ie a muliptle of 0.65x book.

Currently NAV is ~ $10 per share.

It doesn't even take a Hedge Fund Manager on 1.5 and 25 to work out that a share price of $6.50 is 'fair value'.

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