AFC Business model

A depository bank uses leverage every day to earn money. The Federal Deposit Insurance Corporation (FDIC) considers a bank with a 5.0% leverage capital ratio to be well capitalized. A 5.0% capital to asset ratio allows a bank to leverage its capital at 20 to 1. This means that for every $1 in equity capital that the bank has, it can borrow $20 to lend or invest. ($1 / 0.05 = $20). 

The core business model for a Bank is to make money by borrowing short‐term and investing or lending longer term for a spread over their cost of borrowing (Cost of Funds). The percent that a bank earns over its borrowing costs is called a Net Interest Margin or Net Interest Spread. The dollar amount that a bank earns over its cost of funds is called Net Interest Income (NII).

For example, if a banks borrowing cost is 1.0% and it invests or lends the borrowed money at 4.0% then the bank is earning a NIM of 3.0%. Let’s assume the bank has $10 million in equity capital for leverage. And the bank wants to target a 5.0% leverage capital ratio, that means the bank can borrow and invest $200 million ($10 million / 0.05 = $200 million). Therefore, if the bank is earning a 3.0% NIM on $200 million the bank is earning $6 million in Net Interest Income; $6 million income earned on $10 million capital is a 60% Return on Equity (ROE).

Of course, a bank has a lot of employees and operating overhead costs that eats into their NII and reduces their ROE. The AFC simulated traditional bank investment strategy does not have the high operating expenses of a bank so we can and do share the vast majority of the ROE with our partners whom we advise. For risk mitigation purposes, AFC almost always, only invests in AAA – AA government bonds and occasionally global bank bonds that are rated investment grade (AAA to BBB) by the major credit rating agencies (Fitch, Moody’s, and Standard & Poor’s).

Banks borrow very short‐term (overnight / Federal Funds) to a few years from the Federal Home Loan Bank and then lend up to 30‐years in 30‐year mortgage loans. There is more interest rate risk and credit risk in how a bank makes money than in how AFC makes money, but we don’t have the overhead.

AFC also borrows short‐term at the Secured Overnight Financing Rate (SOFR) and only invests out to 1‐to‐ 3 years, depending on the steepness of the yield curve, but typically only 1 to 2 years.  Because we only buy high credit quality shorter term bonds; they are very liquid.