It’s smart in theory. Tetragon, the so-called synthetic bank being spun off by hedge fund Polygon, might benefit from an economic downturn, rather than furling its umbrella like traditional banks.
A recession would prompt spreads in the capital markets to widen significantly, allowing Tetragon to buy loans more cheaply, Andrew Hill notes in his Lombard column. Tetragon could benefit from this because its funding, from the structured credit markets, is locked in for an average of 14 years, while its corporate loans tend to roll over every two to three years as companies choose to change the terms.
Indeed, analysts at Morgan Stanley, which is advising on the float, estimate Tetragon’s returns would drop from an average of 16 per cent to 6 per cent if credit losses tripled to 1.5 per cent of loans. But once the existing book rolls off and reprices to reflect higher defaults, the access to cheap 14-year money should make returns soar.
Of course there are twin dangers, Hill says — namely that losses leap to levels that Tetragon has not planned for, and that the managers choose badly. In the first case, high levels of implicit gearing could wipe out the group’s investments; in the second, the “bank” could end up geared into particularly weak credits.
Also, outside investors are not being offered voting rights in this $300m Amsterdam cash raising. Investors really will have to have faith.