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A CAPITAL MARKETS UPDATE - A TALE OF TWO CITIES

Posted by Gerard Vecchio on May 6, 2020

Specialty lenders and the availability of debt capital for insurance brokers

MarshBerry actively engages with specialty lenders regarding the availability of debt capital for insurance brokers. The insights from our most recent discussions are that the market appears to be a “tale of two cities.” Companies with lower debt leverage and solid business models appear to be able to tap the debt markets at only slightly higher borrowing costs compared to before the pandemic shook the global economy. However, those firms that are more highly leveraged, even if they have quality businesses, are finding borrowing costs significantly higher than pre-crisis.

As we have reported previously in the ViewPoint, interest rates remain at 12-month lows and specialty lenders to the insurance brokerage industry are “open for business” for traditional loans to companies that are not too highly leveraged.  Similar to the insurance merger & acquisition markets for brokers, lenders specializing in the insurance industry are actively seeking borrowers with solid business models, recurring revenues, and stable management teams to provide growth, acquisition and/or buyout capital.  To be clear though, lenders are spending more time on diligence related to the operations of borrowers, especially to determine if a borrower has material exposure to some of the hardest hit sectors such as restaurants or hospitality.

For the typical borrower, this low interest rate environment is proving to be a very attractive time to borrow funds to grow one’s business.  As of the publishing of this article, one-year LIBOR (London Inter Bank Offered Rate), the base rate for many floating rate commercial loans, is less than one percent (~0.83% on May 4, 2020), practically interest free.  This rate has actually decreased by ~17% from the beginning of April (~1.00% on April 1, 2020). 

While 17 basis points is not a large amount (100 basis points = 1.00%), on a $5,000,000 loan, this decrease can add up to material savings for borrowers over several years.  Savings on annual interest charges are $8,500 for a $5 million loan ($5,000,000 x 0.0017).  Over a five-year maturity, this decrease equates to a savings of $42,500 (ignoring the time value of money). For a $10 million loan, savings on interest charges over five years equate to $85,000.

Even through April ’20, MarshBerry has seen sustained banker appetite for less levered credits. Of the three debt raising assignments on which MarshBerry is currently working, all insurance-focused lenders we approached have indicated an interest in providing capital for the loans that are levered at less than 4x free cash flow. Moreover, terms and conditions appear to have only changed marginally from pre-pandemic levels for the desirable loans.  For instance, where total leverage (defined as total senior debt to annual free cash flow) of 4.5x was achievable pre-COVID, today total leverage tops out at 3.5x – 4.0x free cash flow. Similarly, pricing for loans with such reduced leverage amounts are approximately 75 – 100 basis points higher than pre-crisis. 

Not all borrowers are being greeted with open arms, however. We have heard that “storied credits,” those whose financial performance is less than stellar and therefore requires explanation, will likely have a harder time raising debt. We are seeing larger brokers seeking highly leveraged loans (e.g. more than 5x leverage), which were prevalent pre-crisis, are paying much higher interest charges (e.g. over 7% or approximately LIBOR + 650 basis points). This cost is up 250-350 basis points over pre-crisis levels. It should also be noted that the Federal Reserve’s intervention in this highly levered debt market has to some extent provided added liquidity to this leveraged marketplace, which might otherwise be even more expensive (or entirely closed to many borrowers).

In short, the debt markets have become more selective, with solid companies able to borrow at reasonable rates if leverage is not too high. Alternatively, highly leveraged companies, even those with solid business models, may have a more difficult time raising capital, or at least be required to pay higher carrying costs (in the form of higher interest rates).  MarshBerry is happy to assess individual borrowing needs should one have an interest in learning more.

If you have questions about Today’s ViewPoint or would like to learn more about the availability of debt capital in the insurance brokerage market, please email or call Gerard Vecchio, Senior Vice President at 212.972.4886.

As we keep our eye firmly focused on the industry and actions within it, we are eager to know what you are experiencing. Take a quick 3-minute MarshBerry Pulse survey to help us gauge the industry’s response and outlook as the country moves towards “open for business” from the anticipated loosening of stay-at-home orders.

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Topics: Financial Advisory, insurance, economy, brokers, agencies, debt, capital

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