The Price of Time: The Real Story of Interest

by Edward Chancellor, 2022
Winner of the 2023 Hayek Book Prize

Longlisted for the 2022 Financial Times Business Book of the Year Award

In the beginning, was the loan in Mesopotamia, and that loan carried interest at 20%. During the 5,000 years prior to 1913, there was no US central bank and interest rates often ranged between 4% and 8% with a few upward and no downward spikes to zero or negative rates. Is there a ‘natural’ rate of interest the author asks, and if so, how can we know what it is?

I like that this book deftly brings together reading for pleasure and finance knowledge. Edward Chancellor shows his intellectual strength and experience as a financial historian by finding a way to make his protagonist, interest rates, incredibly interesting. While Chancellor doesn’t directly answer the begging question in his book, he points to the recent occurrence of historically low rates now being on an upper trend for a generation. Everyone, not just capitalists or those in finance, should know more about interest rates and how moral hazard forces can come to shape them. In this book, the author showed that overuse of “central banking tools such as the Fed put” led to an “everything bubble” with an inflation “hangover”. With central bankers having now raised rates more aggressively than ever before perhaps we should be asking what price society is willing to pay to reduce inflation towards an arbitrary target. In the first part of the book, he presents the history of interest rates with the observation that if interest rates are looking to escape or perhaps normalize off one in-five-thousand- year lows, then we should prepare for something to go wrong. Throughout the book, Chancellor offers amusing relevant yet poignant tales from the highs and lows of interest rate history including John Law and the Mississippi bubble. The author properly points out how hurtful more recent negative real interest rates are and why a reasonable cost of capital leads to a healthier economy. In addition to looking at the impact of global central banks’ woeful policy of zero/negative interest rates, Chancellor discusses his main character’s far-reaching impact on valuation, capital allocation, saving, risk-taking, capital flows, leverage, and inflation. The book shows that low-interest rates more often lead to wealth inequality, property speculation, poor corporate governance, and frightening levels of risk-taking instead of repairing the economy. Chancellor also shows that the West is not alone as recent easy money in China has inflated an epic real estate bubble there, accompanied by the greatest credit and investment boom in Chinese history. The central bank “put” created by Alan Greenspan and then perpetuated by all his successors and too many of his global piers has spread into several major market shocks over nearly two decades as investors made an ongoing sport of interest rate speculation.

“Interest rates haven’t simply fallen-they were pushed. And by their pushing, the world’s central banks have constructed the hall of mirrors in which every investor has become, of necessity, a speculator. So argues Edward Chancellor in this brilliant chronicle of the most important prices in capitalism. You must read it. It is a masterpiece of history, analysis – and properly managed outrage.” James Grant, editor of Grant’s Interest Rate Observer.

 

Private Credit’s Time to Shine? The year 2022 proved to be challenging for fixed income investors, as interest rates rose and central banks tightened their monetary policies, leading banks to pull back and, in some cases, face failure. The slowing economy added to the stress, resulting in diminishing returns for assets. Furthermore, persistent high interest rates, coupled with banks’ retrenchment, have widened credit spreads for borrowers. This, in turn, is causing existing credit facilities to be refinanced at higher rates, further decreasing returns on equity. However, as lenders are finally getting compensated for their lending, and considering the risk-adjusted basis, credit returns may now outperform equity returns.   As of April, the target United States Fed Funds rate stands at 4.75-5%, leading to losses for banks with longer-dated bonds on their balance sheets. Consequently, depositors are moving their money to more solvent banks or instruments offering higher rates. This has led to intense competition for deposits, which has caused some smaller banks, such as Silicon Valley Bank, to fail. The banks’ search for liquidity and concerns for duration risk has resulted in them holding onto capital, rather than lending into the economy. Meanwhile, despite low unemployment rates, inflation remains high, causing profit margins to shrink and leading to a drop in return on assets. As interest costs rise, returns on equity are also expected to decline. Given these trends, it is expected that investment returns will shift towards different asset classes than those that have prevailed over the past five years. Traditional fixed income investments are likely to perform better, due to the increase in interest rates. However, private credit is expected to benefit even more, since its returns are tied to floating rates, which have increased. Moreover, credit spreads for private credit are expected to improve due to the lower liquidity of banks due to ongoing conservativism and deposit competition. Higher returns are expected for private credit, albeit at the expense of equity returns. Private credit is now poised to shine and could prove to be a lucrative investment option for those seeking non-correlated diversity with higher returns in the current economic climate of slower growth with a higher cost of capital. Is this private credit’s time to shine?

About Bond Capital

Bond Capital is an award-winning private credit fund. As a direct lender, Bond Capital provides advice and money across the entire risk curve. Bond Capital structured credit financing enables business owners to maintain control ownership in exchange for yield and capital preservation. Across multiple cycles and for over 20 years, Bond Capital has advanced secured investment quality credit to lower middle market companies throughout North America.

Hello. My name is Davis Vaitkunas and this is the winter 2023 installment of Bond Capital TV. With the ongoing tricky macro we have a few insights for business loan borrowers and private credit direct landing investors to consider for 2023 and some comments on what’s getting done right now in business credit. Where we at you ask? Well with 2022 in the rear view inflation is projected to ease in 2023. However, this will likely be replaced by ongoing recessionary concerns. And of course, that inflation of publicly posted at 8% is now down at 6% is still quite heightened but I would further observe to shrinkflation and some of my experience as a consumer that that inflation is well under reported. After a 425 basis, point steepest rise ever across 2022, we are not expecting a central bank, monetary policy pivot in 23. We expect the impact from rising rates to hit the economy in 23, and that central bankers, will most likely use that as a cue to slow ongoing increases and then take a wait and see attitude. The era of cheap money is over. Food and energy will cost more than before. That’s what we’re seeing. You’re probably wondering, where does this leave business owners and what are we seeing here at Bond? A few thoughts for borrowers, when the economy is tricky, prices are lower and others are on the sidelines for a variety of reasons,so it’s often a good time to invest, we often call these people contrarians. We have observed, a shift change in liquidity, pricing and renewed conservatism. Most banks have become more conservative too. Even though leverage is well below four times cash flow, and on the move to below three times cash flow. With debt harder to come by borrowers are seeing more covenants, lower leverage, and higher rates. For private debt, UNITRANCH and private debt mezzanine strategies, we are being shown deals, at 55% loan to value and 12, to 14 percent, cash costs, We haven’t seen this kind of pricing for over a decade. Probably not as good for borrowers but certainly an excellent opportunity for investors. What about investors you ask? Given the tricky, macroeconomic setup, investor allocations should be mindful of concentration risk. You just can’t be diversified enough. A well-constructed, modern, allocation model should include 50% alternative assets. 30% public equities,and 20%, traditional fixed income for liquidity management. Within those alternative assets, investors should look for non-correlated diversification and alternative assets that provide interest rate and inflation protection. Private credit happens to all of those marks. Are deals getting done? Lots of behavioral psychology on display here as even lower prices are feared by vendors who are selling out before recession while buyers are fearful of the opposite. That is over buying into a recession. And of course the adage is you make your money when you buy, so certainly by well. These fears are compounded into a 10 to 15% price gap, becoming more common than not, as a result of pure deals are getting done right now. The few actual buyers should be able to prefer missed priced assets in their favor and be able to use a higher discount rate when making their calculations. This higher discount rate is needed to compensate the investor for the recent steep rise in an interest rates and increase cost of capital. So given the higher cost of capital, decelerating growth, ongoing monetary tightening and moderating inflation, private credit will play both an offensive and a defensive role in the business finance community across 2023. Thank you for listening. I hope you found these insights helpful. I am Davis Vaitkunas. From Bond Capital, Private Credit. This has been another installment of Bond Capital TV.

I’m Davis Vaitkunas, and welcome to Bond Capital TV. A few sites and insights as we look forward into 2023. After a year of rising interest rates, high inflation, and lots of interlopers coming into our economy, we’ve all gonna be wondering what’s in store for us next. What we’re seein is more conservative banks, interest rates affecting values, and transactions being more difficult to close because of a gap evaluation. Discount rates obviously are affected by the rise of interest rates which is causing buyers to want to pay less. And sellers are still looking for last year’s prices. It’s probably going to be a slow deal season as we look into the next couple of quarters. On the other hand, if you do need financing we’re seeing lower loan to value from the banks running in the mid-50s, we’re seeing a lot more room for mezzanine debt and junior credit and structured credit. If you’re looking for solutions, that require capital, you should be considering further alternatives, to just a standard bank package. We’re also seeing a rise in prices, and we think that’s what’s going to carry us for forward for the next couple of quarters. Thank you for listening. We’ll have another insert with a few more insights coming up shortly.

The Benefits of a Private Credit Allocation for Investors

Private credit can be a great investment option for investors seeking higher returns, diversification, and control.

Firstly, private credit investments can offer higher returns compared to traditional investments such as stocks or bonds. This is because private credit investments often involve lending to companies or individuals who may not have access to traditional sources of funding, and therefore may be willing to pay higher interest rates to borrow money. For example, a private credit fund may lend private debt to a small business that is unable to get a loan from a traditional bank or access public markets due to a lack of collateral or flexibility on the terms needed. The higher interest rate on the loan helps compensate the investor for taking on additional risk and providing such flexibility.

Secondly, private credit investments can offer diversification benefits to an investment portfolio. This is because empirical evidence has shown private credit investments to be less correlated to the performance of the stock or bond markets. In other words, as an asset with greater downside protection, the value of private credit investments may not rise and fall in the same way as stocks or bonds, which can help to smooth out overall portfolio returns. For example, during an economic downturn, the stock market may decline while the demand for private credit may increase as businesses seek alternative sources of funding due to a lessening of overall liquidity.

Thirdly, private credit investments can offer a level of control and flexibility that is not always possible with other types of investments. For example, because of findings during due diligence private credit investors may negotiate specific terms and conditions of a loan so that the risk reflects a commercially reasonable reward. This will include the interest rate, repayment schedule, and the collateral with tangible value sought for downside protection. This allows the investor to customize their investment to meet their specific risk tolerance and return objectives.

Despite all the challenges faced in public and private markets in 2022, most institutional investors were happy with private debt¹. Preqin’s latest investor survey showed that investors continue to favor private debt for its diversification benefits, capital preservation, and reliable income stream. Investors believe that private debt is the most fairly valued asset class when compared to all other alternative asset classes. The key benefits are floating rate exposure (yield with inflation protection) and downside protection (capital preservation).

Overall, private credit can be a good investment option for investors looking to increase their potential returns, diversify their portfolios, and have more control over their investments. Over the long term, 10%+ yields are achievable for conservatively structured (first and second lien) investment quality secured loans with experienced private equity sponsors or entrepreneurial shareholder groups contributing significant equity to our transactions. High-quality businesses, floating rate returns (defensive relative to a rising-rate environment), excellent loan-to-value, strong financial covenants, and top-tier equity ownership all point to a very constructive and conservative world for private credit managers. Public market volatility, black swan, and/or interloper uncertainty have also reinforced the virtues of private debt for many institutions. The asset class is much less correlated to headline risks and offers a diversified source of income and total return potential, along with interest rate protection for enhanced fixed income. Private debt is very well suited for today’s investing landscape.

About Bond Capital
Bond Capital is an award-winning private credit fund. As a direct lender, Bond Capital provides advice and money across the entire risk curve. Bond Capital secured structured credit financing enables business owners to maintain control ownership in exchange for yield and capital preservation. Across multiple cycles and for over 20 years, Bond Capital has advanced secured investment quality credit to lower middle market companies throughout North America