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” he/she has 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 his or her 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 12-18 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.
Questions To Ask Before You Ask for A Loan
Agency principals should ask themselves key questions to check their strength in accessing capital:
1. Is your agency profitable as a result of receiving profit sharing from your carriers or would you report a loss if the bonus was reduced/eliminated? Well-run agencies, like well-run households, need to live within their means and treat bonuses as windfalls, realizing that they may not always be received.
2. Is your agency consistently in trust? Contrary to popular belief, the balance sheet does matter! An out of trust agency can imply poor financial management (or worse, dishonesty). Related is having adequate working capital. A well-run agency should have 30 days’ of working capital. Stripping the agency of cash only benefits the owner in the short run.
3. Does your agency maintain good financial records and does your accountant produce a financial statement that is reviewed, or at least compiled? While tax returns are useful, bankers prefer to also receive a full set of financial statements with opinion and footnotes. You’ll need to provide three years of financial statements. Be prepared to provide production summaries for the last fiscal year and the current trailing 12-month period. This report should be provided by customer, line, carrier and producer. Also, provide actual insurance company data (production reports or experience reports) from your top five carriers to confirm the data.
4. Do you use the capabilities of your agency management system and compare data with the Big I’s “Best Practices” results?
5. Have you borrowed money from your agency? Pay these loans back, as your banker will not be pleased to see these. Also, if you take a bonus consider loaning some money back to the business to repay debt or replenish working capital. (Bankers like this, particularly if the loans have no set repayment terms.)
6. In a period of lower margins, have you increased your salary or draw? Is spending on your lifestyle reasonable?
7. Are you actively managing your accounts receivable, or are you supplying credit to your clients?
8. Is your balance sheet swollen from an accumulation of unreconciled carrier payables? This is a problem that reflects sloppiness and only gets worse (and more costly to correct) the longer it is ignored.
9. Have you maintained a very good personal credit standing? You will be required to personally guarantee a bank loan, and will likely pledge your stock in the agency as added security. The creditworthiness of a business owner is one of the best indicators of the propensity to repay a business loan.
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.
Robert J. Pettinicchi is chief lending officer of InsurBanc, a federal thrift dedicated to providing banking products and services to independent insurance agent.
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