To The Point: A MarshBerry Video Series

A Discussion on the Debt Market with Max Saffian from Fortress Investment Group, Part I

Join George Bucur and Max Saffian, Managing Director and Partner at Fortress Investment Group, as they discuss the impact of the changing debt market on the insurance distribution segment. The debt markets play a crucial role in achieving rates of return on investments for the buyer and investor community. Specifically, with private capital buyers, who may be significantly leveraged and drive the vast majority of transaction activity. Due to the heightened cost of debt and economic concerns, M&A markets in certain industries have significantly slowed or completely shut down, which adversely impacts valuation. However, given the characteristics of the insurance segment valuations for high quality sellers have not (yet) been materially impacted. Max Saffian shares his insights on the availability and costs relating to debt issuances in this transitioning market.

*Fortress Investment Group is not an affiliate of MarshBerry or MarshBerry Capital.

Video Transcription

George Bucur: Hello, my name is George Bucur. I’m a managing director and co-head of MarshBerry’s specialty practice. Serving MGAs (managing general agent), MGUs (managing general underwriter), program managers, and wholesale brokers, we’re here today to talk about the overall debt market and how it’s been impacting the insurance distribution segment.

Now, I’m very pleased to bring to you Max Saffian, from Fortress Investment Group. Specifically, Max focuses on the insurance sector and, being a managing director and partner at Fortress, has a lot of insights in regards to what activity we are seeing in the debt market specific to the insurance brokerage system.

Now, why is it important for us to dig into this area? At the end of the day, debt markets are controlling a lot of the valuation that we see in many industries, and in some industries, debt has become very challenging to achieve, if not very very costly. However, in insurance, what we’ve seen a a little different dynamic, and now that’s why I want to bring in Max to talk about his experiences specifically and where we sit in the debt market environment today. Max, welcome.

Max Saffian: Thanks, George. Happy to be here.

Bucur: Excellent. So, Max, it has been a very interesting time over the last 12 months, especially if you look at the lower interest rate environment we’ve seen for many decades frankly. Can you talk a little bit about what we are seeing in the debt markets as it relates to insurance distributors—meaning the buyers in the marketplace, largely—and give a bit of background on yourself just to kick things off, please?

Saffian: Sure. So, you know, Max Saffian. I’ve been at Fortress for 15 years. I’m a partner and managing director. I focus on and kind of manage a bunch of our financial services, vertical, that’s across direct lending, corporate— that could be anything from, you know, top of the capital structure loans to lower in the capital structure, you know, co-invest in the equity or preferreds. You know, over the last, call it 4 to 5 years, we’ve been heavily involved in the insurance brokerage and employee benefit space. We’ve built up, you know, a fairly large book of loans, both secured and unsecured, in the space, and at least believe we have a fairly good sort of read on that industry, and, you know, happy to talk about kind of the debt markets and that surrounding that.

Bucur: Excellent. Excellent. So, as many people have probably heard, inflation kicked in in a meaningful way just about a year ago, frankly, and that’s caused a market in transition in the capital market space. Specifically, we’ve seen various tightening and constricting of various debt ratios and whatnot and just an overall cost increase. Max, can you talk specifically about what your experiences have been as it relates to debt-related terms and availability of debt specific to the insurance segment?

Saffian: So, I think it’s a two— it’s sort of a two-part answer. I think the first part of the answer is sort of framing kind of how the debt markets generally work, and you know, some of this is remedial, but it’s worth just sort of reminding everyone who’s listening. And you know, part of that is that most of these insurance brokerage platforms that have been the buyers of kind of the smaller brokers and MGAs, have financed themselves with floating rate debt. So floating rate debt effectively has two components to it. The first component is the risk-free rate, which is keyed off of the Fed Funds Rate. That’s when we hear and read in the Wall Street Journal or CNBC that rates are going higher. That piece has nothing to do with the quality of the company; it’s simply a reflection on the government’s view on where rates should be.

The second part of it is effectively the coupon, and that is keyed off of the actual risk component of the borrower. So, if we think about it, a loan might be LIBOR (London Interbank Offered Rate) plus 500, and that is what the larger platforms will be raising to buy smaller brokers and sort of complete these roll-ups. And two years ago, LIBOR was 1%, and now LIBOR—what’s now SOFR (Secured Overnight Financing Rate)—is 4.5%. When you think about what that means, it means that if you have a LIBOR plus 500 loan, you were paying 6% previously, and now you’re paying 9.5%. And that is a big change in terms of kind of what these companies can pay in order to go out and buy, continue their acquisition strategy.

Bucur: That is, I think, great perspective and something that, as we think about the overall valuation environment, is paramount in terms of how buyers view themselves and ultimately the return on their investments. Because at the end of the day, M&A (mergers and acquisitions) is being done to grow operations and ultimately create returns for their private equity investors. To put it in context, most private equity organizations that are acquisitive are applying somewhere between three and up to eight times leverage.

And Max, we talked about the interest rate aspect of it, but how about some of those other tangential factors that need to be taken into consideration, like debt leverage ratios, etc.? What have you seen in that trend over the last, again, 12 months or so?

Saffian: Yep. You know, I think it’s part and parcel, right? I think there has been a general consensus around these platforms kind of where leverage should be, and that leverage, to your point, tends to be five times through the secured and, kind of, seven times total. The issue now is that, you know, while leverage levels and valuation levels may stay the same, the amount that that costs a platform has simply gone higher because the underlying rates, the risk-free rate, has gone higher. So, I think what we would expect to see is at least some moderation in where that is from sort of a leverage standpoint.

Again, we— I think, George, maybe we can touch on this now or later in the discussion, but it’s worth talking about the underlying quality of these loans versus the rest of the debt markets. Because every fund, like Fortress, is figuring out where they should be allocating capital. Is it healthcare, retail, or insurance brokerage?

Bucur: Thank you, Max. These are all very insightful observations of what is happening within the debt capital markets. There’s much more to explore, so tune in next time when we pick up the conversation with Max and dive into other aspects of the debt markets and how it’s impacting insurance brokerage, specifically valuations and M&A transactions. Until next time, be well.

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