Monday, October 6, 2014

Andy Beal's business model

Andy Beal is an unconventional banker who avoided participating in the housing bubble and made a lot of money buying distressed loans in its aftermath. In 2009, Forbes published an article about him called The Banker Who Said No. The article emphasizes Beal's foresight and maverick personality, but it also describes his business model, and I would argue that this has been equally important to his success.

Beal owns 100% of Beal Bank, which funds itself is by issuing certificates of deposit. Many CD buyers are "hot money" depositors who seek out the CDs with the highest interest rates, and this gives Beal a lot of flexibility in borrowing money: if he sees opportunities to make profitable investments, Beal Bank can quickly raise money by offering high-interest CDs. Conversely, if its existing loans are being repaid and he can't find any new investments, it can reduce its liabilities by letting its outstanding CDs mature.

Few mainstream investors have the same flexibility. It would be very difficult for a hedge fund manager to sit out a boom the way Beal sat out the housing bubble and stay in business. (Michael Burry foresaw the housing bust, but he faced an investor revolt when his housing bets initially lost money.) Even if the manager's clients didn't leave him for underperforming the market, they wouldn't be willing to pay him management fees for holding cash. It would also be very difficult for the typical fund to find new investors during a crisis, whereas FDIC insurance lets Beal raise money with ease.

For a typical bank with a low-yielding portfolio, issuing high-interest CDs is a tough way to raise money, but a high cost of deposits is less of an issue for Beal because he specializes in buying distressed loans that have both higher interest rates and the potential to appreciate. The downside to Beal's business model is that he can't invest widely, e.g., regulators wouldn't let him issue CDs in order to trade stocks or currencies. But Beal's focus is debt– according to the Forbes article, he's bought only one stock in past 15 years– and for that it seems like a fantastic model.

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