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Interest Rates Are Moving Up, How Does That Impact You? by PPCLOAN's Steven Kemper..

2018 Q1

First Quarter 2018 Allstate Agency Value Index

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Values Realize Strong Start to New Year

With the exception of agencies under $1 million in earned premium every size group analyzed by PPC LOAN maintained or increased its value during the First Quarter of 2018 in comparison to the final quarter of 2017. Larger-sized agencies continue to be the most appealing purchase option, as the chart below shows agencies with over $3 million in earned premium were trading at a multiple of 2.90, while agencies with under $1 million in earned premium sold for an average sales multiple of just 1.43 times.

The smallest-sized agencies (those with less than $1 million in earned premium) realized a value less than half of those with over $3 million in earned premium. A driving factor is these smaller sized agencies lack the necessary cash flow to cover base business expenses, and as a result, agencies in this size group struggle to sell as a standalone business. The fact that it takes a significant amount of capital to grow these smallest-sized agencies to a level of scale where the owner can begin taking a salary is a primary driving factor in the low multiples that this size group continues to realize.

Allstate Agency Price to 12MM Earned Premium Ratio (National Average)

$0 to $100,000

$100,001 to $200,000

$200,001 to $300,000

$300,001 and up

Simple Average

Low

High

2000
N/A
N/A
N/A
N/A

0.202

0.117
0.262

2001
N/A
N/A
N/A
N/A

0.209

0.133
0.311

2002
N/A
N/A
N/A
N/A

0.197

0.119
0.255

2003
N/A
N/A
N/A
N/A

0.199

0.147
0.254

2004
N/A
N/A
N/A
N/A

0.236

0.157
0.393

2005
N/A
N/A
N/A
N/A

0.259

0.175
0.398

2006
N/A
N/A
N/A
N/A

0.298

0.188
0.402

2007
2.37
2.65
2.92
3.01

2.96

1.21
4.56

2007
N/A
N/A
N/A
N/A

0.292

0.121
0.456

2008
2.32
2.41
2.74
3.13

2.71

1.45
4.06

2008
N/A
N/A
N/A
N/A

0.271

0.145
0.406

2009
2.14
2.35
2.50
2.78

2.46

0.82
3.97

2009
N/A
N/A
N/A
N/A

0.247

0.082
0.397

2010
N/A
N/A
N/A
N/A

0.24

0.106
0.353

2010 1st QTR
1.94
2.29
2.52
2.91

2.39

1.06
3.53

2010 2nd QTR
2
2.27
2.47
2.8

2.37

1.17
3.16

2010 3rd QTR
2.22
2.26
2.5
2.74

2.43

1.42
3.31

2010 4th QTR
1.94
2.33
2.49
2.76

2.41

1.95
3.28

2011 4th QTR

N/A

0.231

0.12

0.366

2011 1st QTR
1.78
2.36
2.49
2.73

2.47

1.2
3.57

2011 2nd QTR
1.99
2.37
2.41
2.53

2.33

1.2
3.66

2011 3rd QTR
1.89
2.16
2.45
2.7

2.25

1.5
3.66

2011 4th QTR
2.05
2.23
2.45
2.52

2.34

1.62
3.37

2012 4th QTR

N/A

0.229

0.127

0.336

2012 1st QTR
1.87
2.2
2.41
2.54

2.3

1.47
3.07

2012 2nd QTR
1.84
2.27
2.4
2.56

2.3

1.46
3.29

2012 3rd QTR
1.96
2.22
2.33
2.59

2.28

1.27
3.24

2012 4th QTR
2.14
2.21
2.43
2.55

2.39

1.53
3.36

2013 4th QTR

N/A

0.247

0.107

0.349

2013 1st QTR
2.1
2.15
2.38
2.51

2.3

1.28
2.95

2013 2nd QTR
N/A
1.99
2.3
2.57

2.34

1.88
3.07

2013 3rd QTR
2.19
2.18
2.39
2.68

2.5

1.59
3.07

2013 4th QTR
N/A
2.2
2.48
2.74

2.5

1.07
3.49

2014 4th QTR

N/A

0.264

0.107

0.352

2014 1st QTR
1.74
2.32
2.35
2.7

2.38

1.07
3.16

2014 2nd QTR
N/A
2.43
2.47
2.76

2.62

1.73
3.52

2014 3rd QTR
N/A
2.52
2.54
2.77

2.66

1.97
3.45

2014 4th QTR
N/A
2.43
2.54
2.79

2.69

1.94
3.52

2015 4th QTR

N/A

0.251

0.126

0.431

2015 1st QTR
N/A
1.99
2.45
2.66

2.5

1.69
3.35

2015 2nd QTR
1.48
2.4
2.5
2.85

2.54

1.34
4.31

2015 3rd QTR
1.26
2.04
2.71
3.05

2.55

1.26
3.66

2015 4th QTR
1.86
2.22
2.39
2.91

2.43

1.68
3.31

2016 4th QTR

N/A

0.258

0.081

0.378

2016 1st QTR
1.53
2.09
2.47
2.61

2.35

0.81
3.01

2016 2nd QTR
N/A
2.1
2.51
2.79

2.59

1.61
3.78

2016 3rd QTR
2.55
2.15
2.54
2.74

2.58

1.8
3.67

2016 4th QTR
1.8
2.34
2.42
2.76

2.57

1.65
3.24

2017 4th QTR

N/A

0.253

0.118

0.362

2017 1st QTR
N/A
2.21
2.33
2.82

2.61

1.6
3.3

2017 2nd QTR
N/A
2.09
2.31
2.71

2.39

1.72
2.91

2017 3rd QTR
1.18
2.43
2.45
2.84

2.59

1.18
3.51

2017 4th QTR
1.6
2.2
2.29
2.9

2.41

1.6
3.62

2018 1st QTR
1.43
2.21
2.35
2.9

2.62

1.35
3.26

Use the arrows to see agency values over time.

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$0 to $100,000 in New/Renewal Commission

All agencies financed in this size group by PPC LOAN in the First Quarter of 2018 were part of a merger transaction. Half of these sized agencies were purchased and merged by existing agency owners, and the other 50% were purchased and merged by outside buyers. Despite the fact that 100% of agencies with less than $1 million in earned premium were sold as part of a merger transaction, the value for this size group is just 1.43 times in the First Quarter of the year.

$100,000 to $200,000 in New/Renewal Commission

Although none of the agencies in this size group were part of a merger transaction this quarter (last quarter 33% of the agencies in this size group were part of a merger transaction) the average sales multiple increased from 2.20 times in the Fourth Quarter of 2017 to 2.21 times this quarter. One positive contributor to this increase is a significant participation by existing agents as purchasers within this size group.

$200,000 to $300,000 in New/Renewal Commission

Agencies in this size group realized a nice multiple increase from 2.29 times in the last quarter of 2017 to 2.35 times in the First Quarter of 2018. One agency in this size group was sold as part of a merger transaction at a multiple of 3.0 times, and was the sole driver in the increased value for this size group. History supports the statement that agency values will increase or hold strong when the opportunity to execute a merger transaction is on the table.

$300,000+ in New/Renewal Commission

In the Fourth Quarter of 2017, Allstate agencies in this size group realized an eight-quarter high, trading at an average sales multiple of 2.90. This quarter the largest-sized agency group validated this result, by maintaining an average sales multiple of 2.90 for the second straight quarter. Many larger-sized agencies contributed to this healthy sales multiple, as the average earned premium in this size group was significant this quarter at just over $5.5 million.

Percentage of Agency Sales by Size Group

$0 to $100,000

$100,001 to $200,000

$200,001 to $300,000

$300,001 and up

2007 1st QTR

N/A

2007 2nd QTR

N/A

2007 3rd QTR

N/A

2007 4th QTR

N/A

2008 1st QTR

N/A

2008 2nd QTR

N/A

2008 3rd QTR

N/A

2008 4th QTR

N/A

2009 1st QTR

N/A

2009 2nd QTR

N/A

2009 3rd QTR

N/A

2009 4th QTR

N/A

2010 1st QTR

N/A

2010 2nd QTR

N/A

2010 3rd QTR

N/A

2010 4th QTR

N/A

2011 1st QTR

N/A

2011 2nd QTR

N/A

2011 3rd QTR

N/A

2011 4th QTR

N/A

2012 1st QTR

N/A

2012 2nd QTR

N/A

2012 3rd QTR

N/A

2012 4th QTR

N/A

2013 1st QTR

17%

28%

27%

28%

2013 2nd QTR

N/A

21%

38%

41%

2013 3rd QTR

15%

26%

52%

2013 4th QTR

N/A

25%

42%

33%

2014 1st QTR

15%

58%

21%

2014 2nd QTR

N/A

17%

29%

54%

2014 3rd QTR

N/A

43%

52%

2014 4th QTR

N/A

36%

61%

2015 1st QTR

N/A

12%

41%

47%

2015 2nd QTR

22%

44%

30%

2015 3rd QTR

32%

27%

36%

2015 4th QTR

14%

31%

24%

31%

2016 1st QTR

31%

24%

31%

2016 2nd QTR

N/A

14%

35%

51%

2016 3rd QTR

13%

41%

45%

2016 4th QTR

17%

22%

57%

2017 1st QTR

N/A

17%

22%

61%

2017 2nd QTR

N/A

21%

47%

32%

2017 3rd QTR

25%

21%

50%

2017 4th QTR

24%

44%

28%

2018 1st QTR

11%

17%

11%

61%

Use the arrows to see agency values over time.

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The Allstate buy/sell market in the First Quarter of 2018 was dominated by agencies with over $3 million in earned premium, with agencies of this size representing 61% of agencies sold.

Allstate Agency Value Ratios

Agency Price to New/Renewal Commissions

Agency Price to Total Revenues

2007 1st QTR

2.95

2.37

2007 2nd QTR

2.74

2.39

2007 3rd QTR

2.75

2.35

2007 4th QTR

2.49

2.18

2008 1st QTR

2.95

2.38

2008 2nd QTR

2.74

2.39

2008 3rd QTR

2.75

2.35

2008 4th QTR

2.49

2.18

2009 1st QTR

2.65

2.28

2009 2nd QTR

2.5

2.22

2009 3rd QTR

2.42

2.17

2009 4th QTR

2.37

2.17

2010 1st QTR

2.39

2.08

2010 2nd QTR

2.37

2.09

2010 3rd QTR

2.43

2.13

2010 4th QTR

2.41

2.09

2011 1st QTR

2.47

2.18

2011 2nd QTR

2.33

2.05

2011 3rd QTR

2.25

2011 4th QTR

2.3

2.06

2012 1st QTR

2.3

2.02

2012 2nd QTR

2.32

2.05

2012 3rd QTR

2.28

2.05

2012 4th QTR

2.39

2.11

2013 1st QTR

2.3

2.06

2013 2nd QTR

2.33

2.11

2013 3rd QTR

2.5

2.21

2013 4th QTR

2.5

2.19

2014 1st QTR

2.38

2.17

2014 2nd QTR

2.62

2.28

2014 3rd QTR

2.66

2.31

2014 4th QTR

2.69

2.32

2015 1st QTR

2.5

2.19

2015 2nd QTR

2.54

2.21

2015 3rd QTR

2.55

2.24

2015 4th QTR

2.43

2.14

2016 1st QTR

2.35

2.06

2016 2nd QTR

2.59

2.32

2016 3rd QTR

2.58

2.4

2016 4th QTR

2.57

2.37

2017 1st QTR

2.61

2.35

2017 2nd QTR

2.39

2.18

2017 3rd QTR

2.59

2.35

2017 4th QTR

2.41

2.22

2018 1st QTR

2.62

2.4

Use the arrows to see agency values over time.

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For those agency owners residing in a state where a good portion of the homeowners insurance is written through a third party brokerage company (primarily coastal counties), looking at the multiple of revenues may be your best measuring stick for agency value as it takes into consideration both Allstate and brokered (i.e. non-Allstate) revenues. Certainly, the brokerage book is a reliable source of renewal income and has a level of value that is not presented in the traditional multiple applicable to Allstate commissions.

Being the creator and author of the Allstate Agency Value Index has afforded me the opportunity to write countless articles and to travel on behalf of PPC LOAN to speak to both Allstate Management and the Agency force. In the process, I have learned of the challenges former employees have transitioning to being the "boss" of their newly acquired agency.

This quarter I have asked Steven Kemper to share his expertise in the area of interest rates. He has written an insightful article with many points to ponder when borrowing for your Allstate business. If you would like to discuss current interest rates with Steven he can be reached at [email protected] or toll free at 800-456-2779.

Paul Clarke President of PPC LOAN

Interest Rates Are Moving Up, How Does That Impact You?

For the fourth time in the last 12 months, the Federal Reserve has raised the U.S. Prime Rate. As Prime Rate increases, banks are following suit and increasing borrowing costs across the board. Mortgage rates have increased up to 4.5% in the last 90 days for a 30-year fixed note, which is a 15% increase. Similarly, the interest rates on commercial real estate loans are up over 10% to approximately 5.5%. Increasing rates are generally well received as it is a sign of strong economic conditions, but there are two things to remember about a rising interest rate environment:

Purchasing Power: If you are buying or selling a business, the current cost of borrowing money impacts value. Why? The overwhelming majority of buyers are borrowing the money they need to purchase a business and those borrowed funds have to be repaid at appropriate levels of interest. We have lived in an extremely low rate environment for the past 7+ years and interest rates were not a primary factor in impacting the result of business sales and acquisitions. This is changing and buyers would be wise to take notice. See an example below:

If you borrowed $1,000,000 at 6.0% for 10-years, the payment would be ~$11,000 per month. Assume this is the ideal level of debt for the agency to service. An increase in the note rate from 6.0% to 7.0% would decrease your purchasing power from $1,000,000 to $950,000. At first glance it may appear that an agency purchaser must now come up with an additional $50,000 to close the gap in financing. In reality, the majority (if not all) of this pain will be felt by the Seller in the form of a lower purchase price. Most would agree that low interest rates have factored into larger agency values. We all are used to hearing '3-times' when it comes to the sale of larger books. Will this change as rates continue to increase? Transactions over the next 12-24 months will be a good indicator.

Cash Flow Impacts Anyone who has current business debt with a floating interest rate is already feeling the impact of rate increases. Many business owners utilize business lines of credit which feature floating interest rates moving with the U.S. Prime Rate. The impact of U.S. Prime Rate increases might not be significant when loan balances are smaller, but it makes a difference. If, by chance, someone has purchased a business with funds borrowed on a floating rate loan, the impact of increasing interest rates could be much larger. In one conversation we had recently, a business owner's payment had increased over $500 per month over the last 18 months due to higher rates. We recommend that anyone who currently has floating rate debt to look into fixed rate loan options. Even if the rate is slightly higher to get a fixed rate there is still the peace of mind that comes with having control of as many overhead costs as possible and eliminate interest rate risks.
Fixed Rate Availability: As mentioned above, it is in a borrower's best interest to control their borrowing costs as best they can with a fixed rate loan. Who does not benefit from a fixed rate? The lender. While fixed interest rates in a rising interest rate environment is good for the borrower, banks will see profit margins shrink as their cost of borrowing money from the Federal Reserve increases. Banks are for profit and the best way to control profitability is 1) book quality loans that repay in a timely fashion and 2) have their return (the rate of interest they are earning) be in line with the cost of the funds they are borrowing. How do they accomplish this? They offer loans with floating rates or balloon payments. It could become more difficult to find lenders willing to offer a longer term fixed rate loan if rates continue to rise at their current trajectory.

As outlined above, rising interest rates do have impact on business operations and business values. As owners, the most important thing we can do with regard to interest rates is to be aware. From there, you are best prepared to navigate loan decisions and valuation discussions.