Bank and insurance deal maker J. Christopher Flowers says rising interest rates will help the financial sector in the short run, but he’s cautious about any sharp spikes.

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

See Also: Consumer prices soar again and push U.S. rate of inflation to 31-year high

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

A “comfortable level” of inflation would be around a 5% yield on a 10-year Treasury, compared with about 1.5% now and climbing, he said.

See: Treasury yields higher after U.S. consumer-price index rises to 31-year high

Flowers, a Goldman Sachs
GS,
-0.67%

veteran who launched the firm in 1998, said the credit environment has been like something out of the childrens’ classic “Alice in Wonderland”– when the White Knight talks backward or everything is suddenly way out of proportion, for example.

Back when the COVID-19 crisis first hit in 2020, everybody expected credit performance by lenders to be a catastrophe but instead it has been a spectacular success, because Congress and The Fed sent trillions of dollars to people, who then paid back their loans. That’s resulted in a fantastic credit performance for everybody.

“Someday the party has to 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: U.S. jobless claims slip to 267,000 as layoffs fall to record lows

The rise in private credit to record levels of $1 trillion plus to rival the public corporate debt market could also face headwinds from inflation, he said.

“It’s obvious to me in that area, 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 in leveraged loans—it isn’t going to end well if interest rates go up too high.”

Despite these potential pitfalls, Flowers said the financial sector M&A environment remains healthy both in the U.S. and overseas. The firm invests about 50% in the U.S. and 50% overseas, and makes about five deals a year. It expects to maintain that deal pace in 2021.

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

This year, J.C. Flowers has also invested in iLending, a Denver-based auto lending company that helps people refinance their auto loans, and U.K.-based LMax Ltd., which operates institutional exchanges for currencies and cryptocurrencies.

“It’s perked up — it was moribund for a while,” Flowers said of the deal environment in his sector. “It was a little bit like being the Maytag repairman to do banking mergers.”

The firm has owned several banks in the U.S. in the past, but has none at present.

“We love banks,” Flowers said. “The issue is the price. It’s a compliment that they are trading at good prices. They don’t need our help. In general, banks are fine. When things are running smoothly, banks don’t need access to our capital.”

On the other hand, J.C. Flowers has been shopping for banks in Greece. And in April, J.C. Flowers and Bain Capital Credit acquired a minority stake in Co-Operative Bank in the U.K.

Flowers pointed to the firm’s minority investment in LMax as a particularly interesting deal since it’s a forex broker exchange for institutional companies that has more recently added the trading of dollars for bitcoin.

“LMax is like Coinbase for institutions,” he said. “We’re not investing in bitcoin. We provide the platform but we’re agnostic about who wins and who loses.”

Looking ahead, Flowers, 64, continues to stay actively involved with the firm, which recently promoted to managing directors Tim Hanford and Erice Rahe as co-presidents.

“We have a robust deal pipeline with lots of opportunities,” Flowers said. “The environment is terrific but we also want to be in a good position when the bubble breaks.”

The Financial Select Sector SPDR ETF
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+0.09%

has gained 36% in the year to date, while the S&P 500
SPX,
-0.24%

has gained 25%.

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