What Agencies Can Expect Accessing Bank Capital in the Current Credit Crunch

Every morning, stories of financial sector gloom and doom fill the airwaves. A slowing economy has affected the ability of individuals and businesses to pay their bills. The term “credit crunch” has become a part of the daily lexicon, with loan losses and foreclosures at banks reaching record highs.

Experts now believe there to be other problems on the horizon with consumer, credit card, and commercial business and real estate loans. Bank failures and increased regulatory pressure stress the financial system, restricting credit. Only high quality, well-prepared, and creditworthy individuals and businesses will find credit available in this crunch.

Throughout my career, I have observed a flight to quality when credit gets tight. Lenders are less willing to stretch to make a loan. Few are willing to underwrite loans in an industry they do not fully understand nor are completely comfortable with.

Unlike traditional distribution and manufacturing businesses, an insurance agency has a unique business model with low capital requirements and no significant working capital needs (unless there is an acquisition opportunity). But when capital is needed to seize an opportunity, such as the purchase of a competitor, the buyout of a retiring principal, or the lift-out of a business unit, the capital required can be substantial. Since many principals may never have borrowed from a bank, they may not be familiar with how credit is gained.

While not a traditional borrower, insurance agencies still are desirable clients to banks because they tend to be substantial depositors. Banks will preserve this one-way relationship by occasionally making small loans to agencies, impressing the agency principal with the good relationship they have with the bank. But a good test for your banker is to ask if your agency would qualify for a large loan to make an acquisition. If the banker’s eyes gloss over, you may need to re-think your bank relationship.

Understanding the Agency Business

Bankers prefer to make loans to more traditional borrowers with tangible assets. Thus, in difficult credit environments, working with a lender who understands your business becomes more critical for obtaining credit. Despite many banks’ limited credit appetite in times of tight credit, loans to insurance agencies can be a good bet because of good repayment histories and predictable agency cash flows.

Expect all lenders to require financial information for a loan application. Putting together this information should be easy for a well-run agency, but many owners neglect this area. The easiest way for a bank to take a pass on a loan is the inability of an agency to provide financial information.

Also, a banker will treat your loan inquiry as suspect if a request for information is met with: “Why do you need that?” Such responses can precipitate a loan denial.

Types of Loans Banks Offer

Assuming your bank would be willing to make a loan to your agency secured by the assets of the business (rather than based on mortgages on the principal’s residences) here’s what you can expect:

Acquisitions. For most acquisitions or internal purchases, a fully-amortizing five to seven-year term loan is standard. Usually an acquisition will require 30 percent equity in the transaction (which may consist of existing business value). In a perpetuation, anticipate bank financing to account for about 60 percent of the total requirement. The remainder may take the form of a note from the seller or some other deferral. If an acquisition needs a 10- or 15-year repayment to cash flow, it is not an appropriate risk for a bank, nor a good investment for the agency.

Credit Lines. A line of credit may be extended to agencies to augment working capital. Since the working capital need for most agencies is minimal, most line limits are small, representing approximately two-months of commission revenue, or less. Often lines are used to prepay expenses or pay bonuses prior to the end of the fiscal year in anticipation of profit sharing to be received.

Producer Finance. Loans to finance new producers have the look of both a line and a term loan whereby a line is advanced to cover the costs of the new producer during their ramp-up period. At the end of 12 to 18 months, the line balance is converted to a term loan to be repaid over three years.

All bank loans will have covenants, which are promises made by the borrower to the bank regarding the submission of financial reporting and other monitoring factors used by the banks. During this credit environment, financial covenants may still be negotiable, but most representations and standard terms, such as personal guarantees and default provisions, are non-negotiable.

Nine Questions To Ask

Agency principals should ask themselves key questions to check their strengths in accessing capital.

Reducing Risk

A prudent agency owner will seek to borrow the least amount of money for the shortest reasonable period. This will reduce risk, reduce cumulative interest paid, and keep borrowing capacity available for future opportunities. You need to ensure that your business is on solid financial footing to gain access to capital. However, you will also need to present your business in the best light to convince a lender that your agency is a good risk.

As professional risk managers, agency principals must realize that an inability to access capital puts their own business at risk. This threat can be lessened significantly if one understands how to properly position their businesses to borrow from a bank. Uncertain times always create opportunities for those in a strong financial position who can readily access capital.