How The Fed Rate Hike is Impacting Private Lending
New Fed increase
On Wednesday, November 2, as part of their effort to combat inflation, the Federal Reserve hiked interest rates by 0.75 percent, the fourth consecutive increase of that scale, although it insinuated that things might soon start to ease. In an official statement, policymakers mentioned that they will “take into account the cumulative tightening of monetary policy,” in considering further rate hikes. Industries across the economic spectrum have been affected by these policy changes, including private lenders like A&S. But how is this impacting the way our industry does business? Let’s explore.
What effects has the interest rate hike had?
As a direct result of the rate hikes, lenders have been forced to increase their own interest rates, on average of 3 to 4 points. In some capacity, these increases are tied to LIBOR (London interbank offered rate) and the SOFR (Secured Overnight Financing Rate) index. The consequences of such increases have been far-reaching, especially for lenders who follow the conventional “note selling” business model.
Taking into consideration unstable markets and the existence of more secure investment avenues such as government-backed bonds, the liquidity of note buyers has dried up. As a result, lenders who have to sell their notes to continue originating have lost their buyers and can no longer sell their stock of loans. This has driven many lenders to suspend or cease business entirely.
This may sound like bad news, but it’s precisely what the Fed wants. It’s believed that reduced economic activity as a result of a strategically-triggered recession will stop inflation before it spirals out of control and eventually lead the economy back to a growth state. But in the short term, many lenders are struggling.
Why is this?
It has to do with the business model most lenders are using. A majority of lenders who sell their notes have a relatively small amount of equity in their own companies, In comparison with the volume they originate. When they originate a loan, they place it in a credit facility from a bank or similar institution. Then, they immediately sell the note and lose the ability to service it.
When the Fed raised rates, many of these buyers lost their own liquidity. They began to go out of business or place their money into less risky assets like bonds. With almost no one to buy their loans, these selling-model lenders are having a tough time.
How is A&S doing things different?
The most important thing to note is that A&S is a balance sheet lender, an entirely different business model than discussed above. We use our own funds to lend. We make all the decisions involved in our lending practice. We decide who to loan to and have no need to seek approval from a third party.
With this freedom comes more responsibility. That’s why we’ve developed our common sense lending protocols. For one, most of our current new deals come from existing clientele with a history of solid deals. We’re also very detailed in researching and vetting every deal to make sure they’re up to our standards.
So far, our strategy has kept us in good shape throughout these turbulent times. We’ve had to make sacrifices, use more caution, and take on less volume. But where others have gone out of business, we’re still on our feet and plan to keep it that way.