View this article online: https://www.insurancejournal.com/blogs/insurbanc/2023/05/01/718054.htm
This post is part of a series sponsored by InsurBanc.
I reflected on a statement from a recent article on the impact of rising interest rates on agency merger and acquisition activity, particularly with private equity-backed brokers. I stated, “You should not be afraid to borrow, even at the current, higher interest rates, if the use is for productive purposes.”
The current interest rate environment reflects generally higher rates as a result of the Federal Reserve raising the Fed funds target rate to curb the economy to fight inflation. Rates are currently much greater than what was effectively unsustainably low short-term rates to spur the economy after the pandemic. Now, the current prime rate of interest is 8% after a recent low point of 3.25%. However, the 40-year average of prime is 7.6%, so, in the context of a longer time span, prime rates may be at this level for quite some time.
Longer-term rates, such as those for mortgages, business loans and commercial mortgages, have increased but are relatively lower, as rates for those reflect the bond market, and the expectation is that there may be a slowing of the economy. This is the so-called “inverted yield curve” phenomenon.
The takeaway for agency principals is to carefully consider taking on debt and to be attentive to how the rates are being determined by your lender. Borrowing to acquire an agency, or to bring in a group of producers with books of business, is something that can improve the cash flow of an agency, increase the sustainability of your cash flow, and increase the value of your agency. Borrowing money with interest rates in the single digits should work if you are building your cash flow, which should be at a 25% margin, to say the least. This sounds like a productive use to me.
Also, refinancing floating rate debt is a very productive reason to borrow. As noted with the difference in short- versus long-term rates, there may be an opportunity to fix your interest rate to one that is lower — saving interest and improving cash flow, all while reducing the risk of continued rate increases.