Higher inflation could be a ‘Christmas present’ for banks and insurance companies – but only up to a point, says trader

Banking and insurance trader J. Christopher Flowers says rising interest rates will help the financial sector in the short term, but he is wary of any sharp rises.

“If you were to bring a Christmas present to the big banks, higher interest rates would be a good idea,” said Flowers, founder and CEO of New York-based private equity firm JC Flowers & Co., which currently manages approximately $6 billion.

See also: Consumer prices soar again, pushing US inflation rate to 31-year high

Inflation is good up to a point because it increases banks’ net interest income and boosts profitability. But if it gets too high, inflation exerts a “corrosive force” on the entire economy, Flowers told MarketWatch in an interview.

A “comfortable level” of inflation would be around 5% yield on a 10-year Treasury note, up from around 1.5% currently and rising, he said.

To see: Treasury yields rise after US consumer price index hits 31-year high

Flowers, a Goldman Sachs GS,
The veteran who started the company in 1998 says the credit environment is like something out of the children’s classic ‘Alice in Wonderland’ – when the white knight talks backwards or everything is suddenly out of proportion, for example.

Back when the COVID-19 crisis first hit in 2020, everyone expected lender credit performance to be a disaster, but instead it was a success spectacular, as Congress and the Fed sent trillions of dollars to people, who then repaid their loans. This translated into fantastic credit performance for everyone.

“One day, the party must end, but when? That’s such a good question,” Flowers said. “Things that can end it: interest rates go up a lot or if the federal money flowing into people’s hands stops.”

Read: US jobless claims drop to 267,000 as layoffs fall to record highs

Rising private credit to record highs of more than $1 trillion to compete with the corporate public debt market could also face headwinds from inflation, he said.

“It’s obvious to me in this business, we’re having the biggest New Year’s Eve party the world has ever seen,” he said. “It’s such a gargantuan scale – the party of leveraged loans – it’s not going to end well if interest rates get too high.”

Despite these potential pitfalls, Flowers said the environment for mergers and acquisitions in the financial sector remains healthy, both in the United States and abroad. The firm invests approximately 50% in the United States and 50% overseas, and closes about five deals a year. It expects to maintain this transaction rate in 2021.

On Monday, JC Flowers announced an investment in Tricor Insurance, a Wisconsin-based agency that offers business insurance, employee benefits, personal insurance, and individual life and health insurance products.

This year, JC Flowers also invested in iLending, a Denver-based car loan company that helps people refinance their car loans, and UK-based LMax Ltd., which runs institutional currency and cryptocurrency exchanges. .

“It’s reinvigorated — it was moribund for a while,” Flowers said of the trading environment in his industry. “It was a bit like being the Maytag repairman doing bank mergers.”

The company has owned several banks in the United States in the past, but currently has none.

“We love banks,” Flowers said. “The problem is the price. It’s a compliment that they trade at good prices. They don’t need our help. In general, the banks are doing well. When things are going well, banks don’t need access to our capital.

On the other hand, JC Flowers shopped for banks in Greece. And in April, JC Flowers and Bain Capital Credit acquired a minority stake in Co-Operative Bank in the UK

Flowers pointed out that the company’s minority investment in LMax was a particularly interesting transaction, as it is a forex brokerage exchange for institutional companies that recently added trading dollars against bitcoins.

“LMax is like Coinbase for institutions,” he said. “We don’t invest in bitcoin. We provide the platform, but we don’t know who wins and who loses.”

Looking ahead, Flowers, 64, continues to remain actively involved with the company, which was recently promoted to managing directors Tim Hanford and Eric Rahe as co-presidents.

“We have a strong deal pipeline with plenty of opportunities,” Flowers said. “The environment is great but we also want to be in a good position when the bubble bursts.”

The selected financial sector XLF SPDR ETF,
has gained 36% since the start of the year, while the S&P 500 SPX,
gained 25%.

Kristan F. Talley