Higher borrowing costs due to rising interest rates could have a dampening effect on the transactions of insurance brokers in the UK that rely on debt financing.
The Bank of England has raised interest rates three times so far in 2022, taking the rate to 1% from 0.25% at the start of the year. Rates are already at the highest level in two decades and could rise another two or three times before the end of 2022, according to Seán Kemple, managing director of Close Brothers Premium Finance.
“I think it’s going to put more pressure on paying off your debt and also on being able to get money or debt to use for acquisitions,” Kemple said in an interview with the British Insurance Brokers Association. , or BIBA, annual conference .
Many brokerage plans look to generate two-thirds of their revenue growth from acquisitions and one-third from organic growth. But if higher rates make it more difficult for brokers and private equity firms heavily involved in M&A brokerage to get access to money in the UK, there will be a shift to focus. on the organic channel, Kemple said.
The UK, like the US, has long had a very active broker M&A market, in part due to the large number of small and mid-sized brokers ready to buy. Several specialist broker consolidators operate in the market, including The Ardonagh Group Ltd., Global Risk Partners Ltd. and GDP Group Ltd. Many broker M&A strategies are backed by money from private equity firms or credit investors.
Although rising, interest rates remain low by historical standards and debt financing is still relatively cheap, said Bill Cooper, head of capital advice at TigerRisk Capital Markets & Advisory (UK) Ltd. “impact on mergers and acquisitions, but there will be some effect, he said in an interview at the BIBA conference. Much of the effect of higher rates will be confined to the riskier and more indebted end of the market, Cooper added.
More expensive debt will also not affect all potential buyers of insurance brokers. There are plenty of extremely well-funded private equity firms and broker-dealers who will continue to close deals at pace, Kemple said.
According to Simon Collings, managing director of national brokerage and investment at Arthur J. Gallagher & Co. in the UK, high brokerage valuations could put some pressure on private equity-fueled brokerage mergers and acquisitions.
The typical private equity model is to buy brokers between 8 and 12 times earnings and sell them at prices between 14 and 18 times earnings, Collings said.
“There is absolutely nothing left to sell south of 14x,” he said in a BIBA conference interview. “So the challenge for [private equity] that’s how they buy low enough to make a comeback.”
Private equity can move some capital out of insurance to other industries where it can make cheaper acquisitions, Collings said. Higher borrowing costs benefit Gallagher, he said, because they mean the company doesn’t need to take on debt to make purchases.
Although the pace of transactions may slow in the near future, insurance brokerages will continue to attract the attention of private equity firms and other financial investors due to their cash-generating nature, according to Cooper.
“The debt leverage point might dampen prices a bit, but I don’t think it will change the underlying attractiveness,” he said.