Firm sees opportunity where banks see risk: Oak Street has big hopes for insurance agency loans

Bankers like to see plenty of collateral when they underwrite loans. Insurance agents don’t have many hard assets to show them.

Free toasters won’t smooth over this credit dilemma. But the leaders of the Carmel-based Oak Street companies boast they can. And they’re poised to capitalize with a fast-growing specialty lending firm.

“The first line of our vision statement says we’ll build a long-term sustainable financial-services firm,” said Oak Street Chairman Steven Alonso. “It’s our strategy to diversify.”

Founded in 1999, Carmel-based Oak Street Mortgage LLC rode a red-hot real estate market to become central Indiana’s fastest-growing private company in 2003, according to IBJ research.

The mortgage market has since cooled, as have plans Oak Street Mortgage tabled last year for an initial public offering.

But Oak Street’s founders anticipated the real estate market’s slide and founded the specialty finance business Oak Street Funding LLC in 2003 as a countercyclical hedge.

Oak Street Mortgage has grown to 720 employees. Oak Street Funding, which now has a head count of 37, was incorporated separately to bankroll insurance agencies’ expansions or acquisitions by providing loans secured with expected policy commissions.

Oak Street Funding is one of the pioneers in the field, said Alonso, a former CEO of Bank One Corp.’s Consumer Financial Services Division. He said traditional banks have trouble with that sort of intangible asset. But with its basis in actuarial science, the insurance industry is incredibly predictable.

“It’s a matter of taking that predictability, understanding it and then transforming it into a loan,” Oak Street Funding CEO Rick Dennen said.

Oak Street analyzes the cash flows for auto, home, health and life insurance agents and models future earnings. On this basis, it has now made 375 loans totaling $62 million to insurance agents and agencies in 34 states.

On Aug. 1, Oak Street Funding signaled a major expansion. The company announced it had raised $250 million through loans from the Germany-based DZ Bank AG Deutsche Zentral-Genossenschaftsbank and the Boston-based NewStar Financial.

Matt Will, director of graduate business programs at the University of Indianapolis, applauds Oak Street Funding’s ingenuity.

“It is very creative for a company to issue a loan based on a cash flow stream, rather than a tangible asset. And the reality is the cash flow stream is usually more dependable,” Will said. “People do not cancel insurance policies that often. It’s one of the few industries where cash flow is almost guaranteed.”

But what’s good for Oak Street Funding isn’t necessarily a great idea for insurance agencies, Will added.

To turn a profit, Oak Street Funding will have to charge higher interest rates than it’s paying on its own $250 million loan. And because Oak Street Funding is serving a niche that has trouble securing credit elsewhere, it has the opportunity to set high prices.

That doesn’t mean Oak Street Funding is gouging insurance agents, Will said. But borrowers should be wary about abusing this new source of capital.

“This new product comes with a new risk: someone who takes on too much credit card debt,” Will said. “Insurance agents need to be careful about borrowing too much against money they need to live on in the future.”

Roger Ronk, executive vice president of the trade association Independent Insurance Agents of Indiana, said that when traditional banks offer credit, it’s often under terms that don’t fully value an insurance agent’s book of clients.

As the baby boomer generation retires, Ronk said, his industry will have an increasing demand for the kinds of loans Oak Street Funding makes. They’ll be necessary to fund an agency’s sale, often to the owner’s children.

“As long as there’s not a disruption in the cash flow, it generally works pretty well,” Ronk said.

Oak Street Funding customer John Koko, chairman of the Tampa-based KGML Holdings LLC, used a loan secured against his insurance business to establish insurance call centers in India and the Dominican Republic.

“I get the true value of my practice,” he said. “A bank doesn’t understand that.”

Although Alonso calls insurance agencies an underserved market, he doesn’t expect them to remain so forever-particularly once others notice Oak Street Funding’s growth.

“Sooner or later, capital is going to chase it,” Alonso said. “We’ll be in the lead, but there will be others chasing us.”