Evolving Architecture

As a startup co-founder and CTO, I have a number of responsibilities for my business, to quote Eric Reis (http://www.startuplessonslearned.com/2008/09/what-does-startup-cto-actually-do.html), one of these is “platform selection and architectural design”.

I have invested very heavily in this area since starting my journey with Huffle, and this blog is really to capture my thoughts and decision process made along this journey.

As you’d expect my role is currently very varied – I come from a financial technology background, and right now my role is covering all sorts of things, including:

  • Strategy
  • Dev-ops
  • Model development/implementation
  • Platform architecture
  • Server side and front end development (full-stack appears to be the buzzword doing the rounds these days…)
  • UX/design

My posts will likely dip into all of the above, some will be ad-hoc notes, others more in depth discussing strategic directions we’ve taken along the route.

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Musings of a Fintech: Annuity Revolution

I woke up this morning full of inspiration. Forget mortgages, forget payments, we desperately need a new wave of annuity products. These fall under Life Insurance products, so we may need to widen our description from a Lending FinTech to an Insurance FinTech, if we actively pursue the creation of these products. Numbers below indicative…further modelling in progress!

 What are annuity products?

Simply, these offer a fixed payment (which can be inflation indexed…see our next post) until you die or a fixed period expires. As such, they are often used as post-retirement income products. The concept is simple: you want a fixed amount to live off but have no other sources of income. At retirement, you convert your accumulated wealth in your Super into an Annuity. Retirement is then determined by your Super’s size and your planned spending in retirement versus outlook on life expectancy and inflation.


Much of the above is driven by probability and Actuarial analysis. However, to keep things simple, lets assume you want a 30-year annuity paying $449 per month per $100,000. Much of the following is driven by assumptions, available investments, risk and financial models.

Other Assumptions:

  • Inflation will be ignored (it can be hedged with correctly priced equity)
  • Available fixed rate assets paying 4.8% per annum (net of expected losses and charges). Yes, they exist.
  • Protection capital of 10% (credit enhancement and regulatory capital)
  • Distribution and other upfront fees of 1.5% of the notional balance
  • Market rate fixed AAA RMBS yield of 3.5% (this feeds our fair-pricing of $449 per month per $100,000)


We find the above is possible to structure (woohoo). However, the variable component is the subordinated equity, otherwise known as the first-loss or equity position. Plugging in the above numbers into a residential mortgage backed security model (this isn’t simple), we obtain an equity return of 13.7% per annum.

In other words, this is fairly attractive dividend yield. Compare it to investing in major bank shares as it achieves similar returns for significantly lower risk (leverage of 10x on residential mortgages versus up to 40x for CBA, ANZ, Westpac and NAB). We could leverage up this 2x (20x overall) to get substantially higher returns.

Further, we can compare this model to Challenger Liquid Lifetime annuities. Without details on the actuarial modelling, I will assume the age 65 Nil inflation protection will pay for 30 years (the $4139 for males is $349 per month). This has a yield of 1.58% versus our 3.5% and we haven’t even included mortality rates in our model.

Finally, if we add in mortality, returns are stronger for the equity tranche. Taking 65 year old male but the expected longevity of a female to 87 years (i.e. 22 years), we adjust the above model and pay equity the remaining cashflows after year 22. The equity yield before leverage increases to 15.2%.

Put simply, we can get $100 more per month per $100,000 ($449 vs $349) for retirees PLUS significantly better Sharpe ratio returns for equity investors.

Next: more modelling, including inflation options, mortality curve and delayed drawdowns.


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Musings of a Fintech: Short Term Borrowing Growth Trap

If you want to learn about growth, neoclassical models, such as Solow-Swan , can a good starting point. You should also read about the Chicago School of thought. I’m not an economist. I’m a quantitative analyst, bond structurer turned entrepreneur. I usually take all the above and throw it out the window. Partly due to laziness but also from the endless arguments between economic camps – how come they both win the Nobel prizes but still can’t agree on a single item. However the following just seems to make sense to me

For me, growth is a function of population, inflation, innovation and enterprise, random processes and interest rates. This is in some undefined and ever-changing format.

We can roughly forecast population and eliminate random processes through averaging (not always the best thing). Inflation, even if poorly calculated (not including property) can be estimated and removed. Innovation is also random. This leaves me with interest rates and the focus of this article.

I fundamentally believe each person has the capacity to maintain a level of debt, and for arguments sake I will assume this is 30% of gross pay (or approximately 50% of net pay). This is a maximum level that I believe to be stable, any higher and the borrower will default with almost certainty. This isn’t a recommendation.

An interest rate reduction by a central bank, is, therefore an increase in the ability to service new debt if the old debt’s interest rates are floating liabilities (we move further away from my chosen limit). Fixed debt just takes longer to re-price as it matures (or is prepaid, depending on call options). Lower interest rates also suggest, often, that inflation might increase in the future – pulling forward consumption before prices increase. The natural incentive is put in place for people to spend today.

The Reflation Trade:

After the near-collapse of the financial system in 2008, many investors got on the reflation trade: monetary policy aimed to increase the prices of financial assets to not only spur bail-out bank balance sheets but to lower long-term interest rates to increase investment and consumption. This worked well and only really stopped in the US when the Federal Reserve raised rates in December. Japan, the UK and the ECB are still in an easing mode and Australia has more potential scope to cut rates than increase them.

In short this has several impacts:

You borrow to buy assets, the price increases. The obvious asset class is property but this also included in investment and consumption. Interestingly, there has been deflationary pressure at the same time as asset price increases (remember, property is not included in inflation, except for interest rate dependent debt servicing in some countries). Deflationary pressure comes in many forms but an increase in the supply of products and innovation have been factors (innovation including digital products and manufacturing processes). Also remember that inflation has a downward bias as the technology level increases (if the megapixels on a camera double, that is counted as a form of deflation).

Why is the US ahead of the curve?

Firstly, they were more aggressive and much earlier in monetary policy. Assets reflated much faster and some of the financial crisis damage was repaid quicker (e.g. bank balance sheets). In many ways, the US has a better balanced economy, with global tech businesses mostly being based there.

In my mind there is another reason: the consumer can borrow for 25 years with certainty and flexibility.

You can get a 25-year mortgage at a fixed (and very low) rate and still have the ability to refinance even lower or repay when you see fit. This allows the consumer to have greater confidence in their expenditure.

In the rest of the world, this doesn’t happen. You can fix for 5 or perhaps 10 years maximum in many countries but are unable to prepay without hefty fees. The result is that the consumer is then stuck on short-term floating debt and knows they cannot borrow to capacity as they need to be aware of potential interest rate increases (but this actually stops them happening, the fear is the important factor here). Animal spirits cannot occur.

Borrowing from the future?

In short, interest rate declines and locking in long-term low rates is borrowing from the future. This is the whole point: whilst we are low on innovation, population growth or something else random, we need a stimulus as a steady growth rate is better than unstable volatile swings.

Lehman versus Layman:

Interestingly, US banks failed not from their dodgy sub-prime assets directly. It was the short term borrowing that led to their downfall (i.e liquidity). Yes, liquidity was due to shitty assets but the short term borrowing was the reason. It appears the US has learned – albeit it was easier due to the structure of their consumer debt markets.

The rest of the world has passed on the short-term borrowing risk straight to the public.

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