The Debt Markets

The Debt Markets: A Moving Target

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In the past three weeks, the equity markets have been down a lot, then up a little, then down some more. Interest rates have fallen to near zero (and may even go slightly negative before the COVID-19 crisis calms). Does this mean that insurance firms cannot borrow funds to grow their businesses or effectuate an internal perpetuation plan? The answer is that debt capital is still available, but pricing and covenants may change somewhat.

MarshBerry’s market intelligence suggests that lenders to insurance agents and brokers are honoring their existing commitments. Except in extreme circumstances, lenders anticipate closing transactions upon terms to which they originally agreed. Additionally, lenders are receptive to making new loans. In their words, they are “open for business.”

New credits are likely to be more heavily scrutinized than prior to the pandemic. One of the first questions lenders will be asking is whether a particular borrower’s business model will be negatively impacted by this new (temporary?) work-from-home (WFH) environment. Interestingly, in recent conversations that MarshBerry has held with its clients, many have confirmed that a WFH environment has existed in their businesses for a significant period of time, indicating that their workforces have not lost material time or efficiency during the pandemic changeover to WFH.

Prior to the pandemic, debt pricing was razor thin and covenants were down to only a very small number such as failure to pay principal and/or interest, maximum leverage to free cash flow (FCF) and minimum free cash flow coverage. Use of proceeds was virtually unlimited, including the ability to pay out existing shareholders with a one-time special dividend. Early discussions with several lenders to insurance distribution suggest some of this “covenant light” environment may be headed back toward more historic norms.

For example, it appears that initial pricing for new term loans for highly leveraged deals (defined as total leverage of greater than four times FCF) is likely increased by 1- 2%. Therefore, if a particular firm could have achieved an interest rate on its $50 million of borrowing of LIBOR (London Inter-Bank Interest Rate) plus 3.75% before the pandemic, that pricing has likely increased to LIBOR + 5.00%. Similarly, for less leveraged firms (e.g. leverage is three times FCF or less), pricing prior to the pandemic may have been LIBOR + 3.25%; that pricing is likely 0.5% to 0.75% higher today (e.g. LIBOR + 4.00%).

Restrictions on use of proceeds also appear to be tightening. In today’s market, a dividend recap (e.g. paying a special one-time dividend to shareholders) is unlikely to be approved by lenders. But debt capital for organic growth initiatives (e.g. hiring new producers or buying a book of business) is obtainable. Likewise, lenders are still providing funds to complete internal perpetuation plans or to make acquisitions.

If you wish to learn more about borrowing in today’s environment, please reach out to Gerard Vecchio, Senior Vice President, at Gerard.Vecchio@MarshBerry.com or 212.972.4886.

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