The North American M&A market began the year with a relatively strong performance, particularly when compared with the first quarter of last year, driven by tailwinds of activity that originated in December and led to good submission flows in January.
Growth then slowed across the market in mid-January, and remained subdued until late March before deals began to pick up again at the beginning of April.
While there continue to be headwinds for M&A activity from the global macroeconomic environment and geopolitical tensions, one of the main brakes on M&A deals being transacted in North America is a general disagreement over valuations, which is proving challenging for large multi-billion dollar deals, but is typically less of a problem for transactions involving smaller, Mom-and-Pop entities.
As a consequence, we are seeing an increase in deals involving strategic buyers versus private equity investors, due to their differing approaches to assessing the value of acquisitions.
The decision by the US Federal Reserve at the beginning of May to hold steady on interest rates will not have helped with turning around the Q1 slowdown in M&A activity. However, the expectation that a cut in rates is forthcoming later in the year will have potential investors biting their nails in anticipation of a reduced cost of borrowing that could drive further activity.
In the meantime, the uptick in deal flow at the end of Q1 means we are now starting to see some real traction in the market, albeit for smaller deal sizes than we are typically used to, but indicative of a greater level of activity than we saw in the first quarter of 2023.
While we are optimistic about the direction of travel for M&A activity and the accompanying appetite for reps and warranties (R&W) coverage throughout 2024, it’s worth noting that although submissions are now trending upwards, they are still down overall from the peak of 2021, when global M&A volumes reached a record high.
R&W remains a relatively saturated market, with seasoned buyers continuing to use the product as they have in the past, but with no current indications of a material uptick in interest from new clients. In keeping with the general soft market dynamics, coverage has broadened, with lower retentions and deductibles and any available exclusions being applied at the quoting stage.
In such a competitive environment for R&W coverage, Liberty GTS is demonstrating its dedication to clients by continuing to add value through our claims expertise and handling. As our annual claims briefing indicates, we have been tracking claims data for several years, which not only drives better underwriting but gives our clients greater comfort about the reliability of the R&W product.
One of the major trends in the R&W market both this year and in 2023 has been the growth of coverage for secondary transactions. Companies are becoming increasingly innovative in how they structure and effectuate transactions, and the lighter-touch due diligence and greater ease in handling for secondary transactions has led to a huge uptick in such deals.
Historically, the R&W market hasn’t typically covered this area, but with brokers also demonstrating greater innovation in how they apply R&W coverage to different transaction types, we are seeing more of these risks entering the market.
We have also seen an uptick in mergers of equals, where buyer and seller are capitalising on the ability to avoid using cash and/or debt to finance deals, while experiencing increased synergies through the combined entity.
All of this points to a longer-term shift in the M&A market, where companies are looking to hedge against any slowdown in activity by venturing into other vehicles or transactional structures, while M&A insurers are looking to diversify by exploring opportunities adjacent to the R&W space, with a growing focus on contingent risk coverage and tax insurance.
That said, we expect to see a slow and steady increase in submissions for R&W coverage throughout the remainder of the year, contingent to some extent on what happens with interest rates. Buyers have a healthy appetite for the coverage and are keen to release capital and invest in M&A deals, but will retain a level of caution while uncertainty around inflation and interest rates persists.
At the same time, a more realistic mindset is bedding in, where M&A players are beginning to acknowledge that they are operating on a new playing field, where deal volumes are unlikely to return any time soon to the highs of 2021. Buyers are therefore getting used to the reality of higher interest rates and are factoring that into their budgeting for next year.
We believe that an element of the recent uptick in deal activity reflects this changing mindset. Some buyers have overcome their reluctance and are now showing greater willingness to engage in this new market. Over the next 12-18 months, we are likely to see more players doing deals, in spite of the challenging economic environment.
As such, we see this as an ideal opportunity for prospective buyers who haven’t previously used the R&W product to dip their toes in the water, and make the most of underwriters’ willingness to engage with submissions across a wider range of risks than the market has formerly considered.
