New York, NY — Decowraps received an investment from Palladin Consumer Retail Partners. Deerpath Capital Management LP provided financing for the transaction, which will help expand the business. The financing package includes an unfunded acquisition line and a revolving credit facility to support future growth.

Decowraps, based in Florida, manufactures packaging for fresh cut flowers and potted plants. The company operates design, production and distribution facilities in Colombia, The Netherlands, Ecuador, Kenya and China.

New York, NY — Deerpath Capital Management, LP today announced it acted as sole lead arranger and administrative agent on the funding of a senior credit facility to support four acquisitions by Togetherwork Holdings LLC, a portfolio company managed by Aquiline Capital Partners, LLC.

Togetherwork is an emerging leader in payment processing software for groups and organizations of all kinds. Building on the foundation of Omega Financial, LLC, Togetherwork aims to acquire software companies in adjacent verticals, creating a family of companies that provide similar technology and services to broader organizations such as sports leagues, summer camps and cultural and educational institutions.

New York, NY — Deerpath Capital Management, LP acted as lead arranger and administrative agent on the funding of a senior credit facility to support the growth acquisition plan for Southern Dental Alliance ("SDA"), a portfolio company of Source Capital, LLC. Deerpath has helped finance five of SDA's most recent add-on acquisitions since August 2016.

Southern Dental Alliance is a multi-specialty dental service organization in the Southeast catering to pediatric and adult patients. Headquartered in Atlanta, Georgia, the Company operates 32 clinics across seven primary brands in Georgia, South Carolina and Tennessee.

New York, NY — Deerpath Capital Management, LP today announced it acted as sole lead arranger and administrative agent on the funding of a senior credit facility to support the refinancing and growth plan for The Shade Store, a portfolio company of Great Hill Partners.

The Shade Store is a leading direct-to-consumer provider of custom window treatments, offering shades, blinds, drapery, and other window treatment products and services online and through its 47 branded showrooms. Since its founding, The Shade Store has developed a national brand synonymous with quality, value and service.

Chicago, Illinois — Deerpath Capital Management, LP today announced it acted as sole lead arranger and administrative agent on the funding of a senior credit facility to support the recapitalization of Castlewood Treatment Centers by The Riverside Company.

Castlewood is a leading provider of inpatient and outpatient treatment services for patients suffering from eating disorders and other co-occurring disorders such as anxiety, trauma, chemical dependency, and depression. The Company provides residential treatment, partial hospitalization, and intensive outpatient treatment.

Chicago, Illinois — Deerpath Capital Management, LP today announced it acted as sole lead arranger and administrative agent on the funding of a senior credit facility to support the recapitalization of Insurance Technologies, LLC, a portfolio company of Moelis Capital Partners, which is co-advised by NexPhase Capital.

Insurance Technologies provides sales and regulatory automation solutions to the insurance and financial services industries. The Company's products, ForeSight® (sales illustration) and FireLight® (electronic applications), supply carriers and distributors with sales tools needed to streamline and accelerate the sales process.

The government’s US$284bn Paycheck Protection Program (PPP) reopened this week and is expected to aid struggling small and middle market businesses, as well as have wider reverberations across the private credit market.

Many non-bank lenders and business development companies (BDCs) accessed funding for their portfolio companies in the first round of the PPP in March. Many lower middle market lenders are likely to tap into the funds again. BDCs such as Saratoga Investment Corp, Fidus Investment Corp, and Gladstone Capital Corp reported in their first-quarter earnings report in May that they obtained funding from the program. One of them -- Whitehorse Finance, a specialist non-sponsored lender -- secured US$50m in funding for 14 of its companies.

"It helps that there is more liquidity for small and middle market-sized businesses. It relieves a lot of stress. One of the biggest benefactors of these loans is the equity owner, who is relieved from having to put in further equity and dilute their holding," said Reed Van Gorden, a managing director at Deerpath Capital Management, a direct lending firm. First-time borrowers can obtain loans up to US$10m if they employ less than 500 people.

Companies returning to the PPP are restricted to loans totaling no more than two and half times payroll with amounts capped at US$2m. The companies must have a maximum workforce of 300 people and can demonstrate a 25% decline in revenue in one quarter of 2020 compared with the same period in 2019.

Loans are forgiven if a company uses 60% of its loan to cover payroll and employees are not made redundant. The loans have a five-year maturity (two years if issued before June), are unsecured, and carry a 1% interest. The Small Business Administration’s (SBA) affiliation rules mean that many sponsored-backed companies cannot enter the program, precluding many private credit firms that target this market. However, the wider private credit market is still expected to benefit from the program as the extra liquidity provides stability across all financial markets.

"PPP stimulus was a very successful program. Companies that accessed funds as a precautionary measure were able to keep their workforce and avoid any restructurings," said Matt Harvey, head of direct lending at investment firm PGIM Private Capital.

Against the background of the PPP launch, a combination of monetary and fiscal policies last year also helped to create a healthy lending environment for middle market companies, said Harvey.

"The additional liquidity created a more patient and accommodative environment across equity and credit markets. Valuations improved, and there was a normalization of the cost of capital, with rates now returning to pre-Covid levels," Harvey said.

US President Donald Trump signed into law the Consolidated Appropriations Act in December, renewing the PPP policy launched in March as a way to provide relief in the short-term for small businesses hit by the coronavirus pandemic.

The traditional banking sector predominantly administers the PPP. Until its closure in August, US$525bn of PPP loans were made to small and middle market businesses, according to the US Treasury. While non-bank lenders are eligible to participate in the PPP, many have not. The average size of a PPP loan was US$100,000, SBA figures show, significantly below the amounts lower middle market target. For instance, Fidus targets companies with a minimum of US$10m in revenue. Saratoga said its minimum is US$8m in revenue. Gladstone Capital’s requirements is slightly higher, with a US$20m revenue requirement. BDC Newtek Small Business Finance is one exception to the non-bank lending market and has again signed up to participate in the second round. The BDC provided US$1.19bn in loans under the PPP last year. Some believe that the PPP would benefit from greater participation from private credit lenders.

"After the launch of the PPP in March, the money just flew out the door," said Suzie Saxman, partner at law firm Seyfarth. "I think it would be fabulous if some non-bank lenders did try to become qualified. They have access to a different segment of the market."

About Deerpath Capital

Deerpath Capital Management, LP is a leading provider of senior debt financing to US lower-middle-market companies. Since inception, Deerpath has completed 300+ investments, deploying $2.2bn across a broad range of investment products and transaction types. Visit www.deerpathcapital.com to learn more.

As part of the fifth annual LPGP Connect Private Debt Fundraising Conference, Richard Phillips, Director of Private Debt at the Aztec Group, moderated a virtual discussion on the future of private credit. Richard was joined by Sandro Näf of Capital Four Management, Antonella Napolitano from Deerpath Capital Management, Ross Morrow from DunPort Capital Management and Ewan Macaulay of MetLife Investment Management.

Moderator, Richard Phillips (RP): The focus of our discussion is the future of private credit, but can you share your reflections on 2020?

Sandro Näf (SN): March was particularly tough. First, we had to work our way through the portfolio to see what was affected most. Then, we needed to consider how our LPs would want us to behave before moving forward with the investments we had. This meant working closely with portfolio companies, introduced new covenants and business plans that would hit different key performance measures in the light of COVID. It was about striking the right balance between being supportive for companies while doing what our LPs would want us to do.

Antonella Napolitano (AN): Valuations took an enormous hit across the board in Q1, and deal flow plummeted for the better part of Q2. On the LP front, investors took a pause on allocating, and focused on existing portfolios. We saw an immense pick-up around August and September, and in the US, a lot of lending firms had their best September and October deal volumes ever.

Ross Morrow (RM): We had experienced our two busiest quarters in Q4 2019 and Q1 2020, then everything came to a shuddering halt in Q2 of this year. But towards the end of Q3, we began seeing investors willing to reassess or consider new risk. Patience, forbearance and a focus on liquidity was the name of the game for the last six months.

Ewan Macauley (EM): This has been a real-life stress test for all of our portfolios. We have definitely seen a return of clients looking to deploy capital, and also in terms of issuers looking to tap liquidity. One of the benefits of our asset class is that it should perform well compared to other types of debt, or other financial instruments, during a downturn. We’re not out of the woods yet, but it’s been encouraging to see this being borne out.

RP: What challenges, in terms of valuations, do you see coming next year?

SN: The true test of any private debt manager is dealing with those inevitable, difficult situations, and in protecting and recovering value via active management. This means valuations need to be considered through to the lens of a fund’s ability to follow their money, as well as to be able to hold an asset for an extended period where necessary.

RM: We won’t shy away from the fact that some assets may be underperforming relative to their underwriting case. Being transparent, and communicating with your LPs in a clear manner, is important, but you should also be able to explain how you plan to deal with a particular challenged asset. When speaking with our LPs, we have a very clear policy of how we will value our positions and the steps we are prepared to take, regardless of the market backdrop.

EM: Valuations are important, but people need to view things through a long-term lens. This is an illiquid asset class, and all the protections we put into our investments are designed to allow us to ride through the peaks and troughs seen during economic cycles. We remind clients not to get overly fixated on month-on-month movements, and that usually the best approach is to look at the asset over the long term.

AN: We typically get each portfolio company revalued independently once a year, but we revalued our book during COVID because we thought investors needed an independent view of the entire portfolio in light of the unprecedented environment. Valuations declined about 5%, but since then, we have seen writeups each quarter as businesses recover from shutdowns and regain pre-COVID profitability levels, as we continue to receive interest and principle on all of these loans and also as market-required yields stabilise.

SN: These are good opportunities to be transparent about processes and show LPs how we work with third parties to issue valuations. Of course, LPs are grateful when we can add colour to the valuations and explain what’s going on, not just throwing numbers at them.

RP: Are there benefits to having a sponsor in certain transactions, particularly given the liquidity stress of the past six months?

AN: I would say 90% plus of our deals are sponsor-backed. When sponsors put a substantial amount of equity into the deal, the sponsor acts like an airbag cushioning you against an accident. The sponsor has an economic incentive to protect their investment and support companies, because they have a lot at stake. If we didn’t have sponsors in place, we would be doing more restructurings these days.

RP: What are you sensing when it comes to future allocations of capital. Will there be deployment opportunities?

RM: You hate to refer to the pandemic as an opportunity, but its impact will clearly create opportunities for private debt participants, particularly in Europe. I think there will be managers that, over the course of 2021, will reap the benefits of how they responded to the pandemic this year. The “proof is in the pudding” as they say, and I think LPs appreciate how private debt as an asset class has gotten through this first great test.

EM: We felt allocations would probably be quiet for the rest of the year, but we have seen a noticeable uptick in interest over the last six to eight weeks. People are realising that private debt has been holding up well, and have a bit more confidence now than they had back in the spring or the summer. It definitely seems to be going in the right direction.

RP: Will there be a shift in borrowing undertaken as a result of COVID, maybe even contrasting with how the global financial crisis impacted markets back in 2008?

SN: I’m proud the market has done so well through this test period. In contrast, bank solvency mechanisms are still based on centuries-old thinking, lending within a structure that forces you to raise money at the worst possible moment! None of that applies to private debt. Not one single LP came to us in March and said they wanted their money back. More importantly, we can show LPs how we managed the situation with companies during some very challenging times.

RM: Most borrowers and sponsors have had a relatively positive experience that will give further confidence to market participants that this structure works. But for borrowers, working capital still needs to be funded, and bank appetite has just about disappeared. Can private debt lenders step in and provide some form of working capital solution for companies? I think that question is yet to be answered.

RP: What are your thoughts on how EBITDA (earnings before interest, taxes, depreciation and amortisation) is going to be assessed in the coming 12 months?

RM: Pressure has been building on covenants generally in recent years. Lenders are always very focused on cash flow but particularly in the last 12 months. There will be more scrutiny on definitions like EBITDA, as well as covenants more generally, to make sure that they are fit for purpose. Personally, I think definitions will begin to tighten up somewhat in favour of Lenders, but time will tell.

AN: We have always been very careful on EBITDA add-backs generally, and there has been something of a trend for sponsors to try to get approval to add-back even forgivable covid-related government loans as income. That’s not a true company cashflow line item that a company should get credit for, so that’s something we’re continuing to monitor.

RP: Can we finish with your expectations for 2021?

AN: Everything is going to be scrutinised more closely now, particularly with companies that suffered even a mild COVID impact. We now require 13-week cash flow forecasts from companies, because we need to estimate any future imminent liquidity needs that weren’t part of our initial investment thesis. Potential new shutdowns and renewed social distancing across the U.S. coupled with no movement on additional fiscal stimulus, makes the near-term economic environment quite uncertain. This is why it’s important to invest in a strategy designed to provide protection when uncertainty is high. The direct lending asset class is here to stay. Every survey suggests LPs are either sticking with their same allocation or increasing.

SN: We now have a thriving private debt market that uses debt as a capital instrument for companies to thrive under private ownership. These are not weak companies; they are businesses empowered by capital structures that incentivise management and employees. So, investors will want more of this, and companies will want to use it more as a capital instrument. Things will only go one way from here.

RM: I echo the positivity of the panel, but we shouldn’t underestimate the levels of government support that still needs to wash its way through the system. Also, we’ve seen a huge amount of flow and volume into so-called ‘COVID-proof’ businesses. These are interesting companies, but none of them are isolated from all the other normal business risks that come with day-to-day transactions.

EM: We are still cautious, but so far, the asset class has stood up really well to this real-life stress test. Some clients have viewed private credit as just a bit of yield pick-up compared to what is available in the public markets. The value of true downside protection - in the form of covenants - has now been proven in real-time, which will give LPs more belief in the benefits of private credit in future.

To watch the roundtable, please click here

In the $850 billion private debt market, it's the jumbo deals that tend to get the most attention. But the smaller transactions, to mid-size businesses that employ a large swath of Americans, make up most of the activity in the asset class.

Looking ahead at the remainder of 2020, the lower middle-market -- broadly classified as financing to borrowers with less than $50 million in annual earnings -- is likely to see a rise in activity, though far off the highs seen in earlier years due to the pandemic. Here, lenders that focus on smaller borrowers, weigh in on the dynamics they're seeing, including higher yields and less competition.

Tas Hasan, partner at Deerpath Capital Management, which typically invests between $15 million and $50 million per deal:

"Our strategy has always been to do a larger volume of the same size transaction versus growing by doing a small number of larger deals in a very competitive space up-market. While there's been a lot of growth in terms of players in the lower-middle market segment, you are not competing with 90 other lenders to do one $100 million loan."

Brett Hickey, chief executive officer and founder of Star Mountain Capital, which makes investments ranging from $5 million to $50 million:

"We've been very active, across two primary camps of investing: one is helping existing portfolio companies acquire challenged competitors as well as helping structure, negotiate, finance and integrate multiple other strategic add-on acquisitions, in addition to investing debt and equity capital into new platform companies. I would say covenants and pricing for the non-sponsored lower middle market have remained strong -- typically these business owners don't want high amounts of leverage and they don't mind giving protective covenants."

Marc Cole, CEO of SG Credit Partners, which provides loans of about $1 million to $10 million:

"The economics have largely been sector driven. In software, where we're highly active, we are seeing it be more competitive than pre-Covid lending. In broad based industries, within an asset-based lending umbrella, then we're seeing more conservative terms across rates, collateral coverage and lending covenants that is a significant tightening over the pre-Covid credit bubble."

Charlie Perer, head of originations at SG Credit, which provides loans of about $1 million to $10 million:

"We're absolutely seeing a period of banks tightening. We're busy for a few reasons: PPP has worn out, companies have to find a way of financing their working capital and borrowers in the lower end of the middle market aren't really able to access private equity capital."

Albert Periu, CEO and founder of San Francisco-based lower-middle market lender Neptune Financial Inc. (NepFin):

"One thing that we're seeing more and more of is lenders partnering on deals. Lenders are reserving capital for loan losses, or they're being more conservative and they want to diversify their risk. The uncertainty is still there, but we're also seeing processes that we didn't expect to be as competitive as they were. Overall, though, we're still seeing spreads 50 to 100 basis points higher than before Covid."

About Deerpath Capital

Deerpath Capital Management, LP is a leading provider of senior debt financing to US lower-middle-market companies. Since inception, Deerpath has completed 400+ investments, deploying $3.3bn across a broad range of investment products and transaction types. Visit www.deerpathcapital.com to learn more.

Over the past year or so, the leveraged loan market has taken quite a beating in the press. There was good reason for this. On the whole, this market had a very risky investment philosophy: stretch on credit risk in pursuit of higher yield. As competition intensified in the direct lending market - particularly in the larger company space with loans of $50 million and upwards - and as yields declined, lenders in the leveraged loan market have had a more laissez-faire attitude when it came to upholding high credit standards.

As direct lending continued to flourish following the global financial crisis, corporate lenders began to loosen their investment discipline in order to win new deals and maintain robust deployment numbers amid increased head-to-head competition from direct lending. Lenders started to provide surplus leverage to large borrowers, further fueled by aggressive addbacks. They also began to eliminate financial covenants and set up very borrower-friendly structures. Some of these structures left lenders unprotected from collateral transfer and open to certain 'accordion' features, which gave borrowers the power to draw more debt from the lenders in future without additional consent.

Up until covid-19 placed an abrupt halt to daily life and shuttered businesses around the world, the direct lending environment was unquestionably borrower-friendly. Many lenders saw leverage levels swell to 6x or more and loan-to-value ratios increase to 60 percent and beyond. As a result, cash interest coverage ratios declined. Risk mitigating mechanisms, typically synonymous with an investment in a first lien loan in the US, were disregarded. Most of these loans lacked a full package of quarterly financial covenants, which are key in the measurement of, and timely reaction to, company performance and used to be standard for first lien paper. When there are no covenants in place, the lender is unable to take any action until the company defaults on its interest payments. By the time that happens, the company and the lenders are both in trouble.

Lending to performing companies was designed to be an asset class that provided predictable and stable yields with built-in safety protections to furnish steady returns during market booms and ensure capital preservation during market declines. Moreover, when a bubble is building, mitigating downside risk should be paramount. But downside risk protection against even a moderate recession was not a priority for many lenders. Worse, covid-19 arrived without warning and wreaked havoc on the markets. This year, we have seen wild and unprecedented swings in the public equity and fixed-income markets.

With the first quarter now behind us, what can we expect to see in the private lending market in terms of existing portfolio valuations, covenant breaches and recovery rates? What will new dealflow look like in terms of leverage levels and pricing?

Valuation decline

Private equity firms and lenders alike will see a decline in valuations for Q1 and probably for Q2. This will be especially so for those exposed to sectors hit hard by the pandemic (such as airlines, hospitality and energy) and, to a somewhat lesser degree, businesses in the US that have been mandated by state governments to temporarily close (location-based product or service companies). If the result of covid-19 winds up being a full-blown recession in the US, then many more businesses will be affected.

Lenders that aggressively levered up their borrowers' balance sheets and created covenant-lite structures in the pre-covid deal environment will no doubt see payment defaults spike, losses pile up and recovery rates fall at higher rates than those that lent at much more conservative levels.

Also hard-hit will be those lenders that had a high percentage of non-sponsored transactions. In those cases, it will be the lenders (and not the equity sponsors, as will be the case in sponsored transactions) that will need to provide all the rescue financing and take on the burden of ensuring companies are able to withstand this period of pain.

One area we believe will continue to thrive is the lower mid-market (loan sizes just below $50 million). These corporate borrowers are large enough to have sufficiently strong underlying characteristics to be a safe credit risk, and have credit ratings on a par with or perhaps better than those at the higher end of the mid-market due to lower leverage levels. The level of safety one would have otherwise assumed when investing in a large company has been diminished by the high level of risk created through aggressive leverage levels, no covenants and limited rights when the company underperforms. This has made the very large loan a very risky one.

The lower mid-market had less competition before covid-19, and lenders in this space had more rights than those in the core mid-market. As such, lower mid-market lenders were able to maintain lower leverage levels (3-4x compared with 5.5x or more in the core mid-market), lower loan-to-value ratios (40 percent versus 60 percent or more) and keep EBITDA addbacks at bay. Lenders in this space are also able to manage loans actively by requiring board observer seats, monthly and quarterly financial statements, quarterly compliance certificates and annual independent audits. Superior visibility into borrower performance coupled with control of the loan voting rights allows the lender to exercise its rights early on in order to firmly address problems before they result in payment defaults or loss of principal. Many of these characteristics have been unavailable in the larger loan market.

Although no lender will be left unscathed by the pandemic, those that will persevere are the ones that have insisted on three things: low leverage levels to withstand a steep decline in earnings; partnerships with private equity firms that are willing to support companies by infusing additional equity capital; and abundant lender rights that did not recede during the benign economic environment of the last few years.

As this downturn plays out, we will be left with a direct lending landscape of few players as managers with overleveraged portfolios fall away due to performance and liquidity issues as they manage broken portfolios. One significant impact of covid-19 will be a change in the direct lending market that will mirror the years following the global financial crisis, when credit was strained and therefore extremely expensive once it had been procured. This will create attractive opportunities for direct lenders in the US.

Lenders that created a portfolio full of loans to good-quality businesses at responsible levels of leverage with private equity sponsors and full covenant protections will not be hindered by severe illiquidity resulting from distressed portfolios that were built over the last few "boom" years. Instead, they will be able to deploy dry powder in a disrupted market that will be very attractive for lenders. As quality businesses look for loans in a credit-strained market, lenders will demand higher pricing and added protections. We will also see covenants and other protections coming as lenders once again become more stringent on structures and terms.

Antonella Napolitano is managing director and head of investor relations and business development at Deerpath Capital, a US-based provider of cashflow-based senior debt financing to lower mid-market companies.


About Deerpath Capital

Deerpath Capital Management, LP is a leading provider of senior debt financing to US lower-middle-market companies. Since inception, Deerpath has completed 400+ investments, deploying $3.3bn across a broad range of investment products and transaction types. Visit www.deerpathcapital.com to learn more.

New York, NY /PRNewswire/ — Deerpath Capital Management, LP announced the closing of Deerpath CLO 2020-1, a $325 million collateralized loan obligation (CLO). This CLO represents the second CLO issued by Deerpath in the last 16 months and brings the company's total CLO assets under management to approximately $635 million. Deerpath CLO 2020-1 will primarily invest in leveraged loans to middle market private equity-backed companies.

The Fund has a three-year reinvestment period and a collateral pool comprised of a diversified portfolio of senior secured loans. Deerpath sold securities rated from AAA through BBB-. Deerpath managed funds purchased 100 percent of the subordinated notes issued by the CLO. GreensLedge Capital Markets LLC served as Lead Placement Agent, Structuring Agent and Bookrunner. Raymond James served as Co-Placement Agent.

Derek Dubois, Managing Director and Treasurer said, "Our second middle market CLO demonstrates our continued success in the capital markets. This transaction gives our fund investors access to sturdy, conservatively structured leverage at attractive pricing. We continue to broaden and diversify our investor base by introducing new institutional investors to our direct lending platform and welcomed the participation of repeat investors from our previous CLO offering. We were very pleased by the quality of execution from the Greensledge Capital Markets and Raymond James teams and the level of support we received from the investment community through challenging market conditions."

About Deerpath Capital

Deerpath Capital Management, LP is a leading provider of senior debt financing to US lower-middle-market companies. Since inception, Deerpath has completed 400+ investments, deploying $3.3bn across a broad range of investment products and transaction types. Visit www.deerpathcapital.com to learn more.

New York, NY (LPC) - Lending to companies with just a few million dollars in earnings is gaining greater interest from investors seeking higher yields and better protections as the private credit market grows increasingly segmented and sophisticated.

Firms are looking to raise funds to target companies in the lower middle market, or companies with an Ebitda of less than US$15m, including Deerpath Capital Management, which wants to raise US$1bn for its lower middle market fund, and PineBridge Investments, which announced it has US$596m to invest. At the same time, Main Street Capital Corp said it is continuing to seek opportunities in this segment.

Lower middle market loans have less leverage and come with higher interest rates to reflect the heightened risk and limited liquidity of smaller businesses compared with those in the core middle market.

Direct lenders have flourished in the last decade by tapping into the core middle market, or companies with US$15m to US$50 in Ebitda. It's an area that some banks have been hesitant to lend to, allowing these financing providers to offer private equity sponsors extra leverage and flexibility at a premium.

But the growing size and sophistication of funds, as well as heightened competition, have weakened terms for loans made to companies with larger earnings.

Private credit firms attempting to win deals in this segment have increasingly come to accept lower spreads. In the fourth quarter of 2019, interest rates on unitranche loans, which are an indicator of the pricing pressure in the middle market, hit a historic low of 578bp, according to data from Refintiv LPC.

Unitranches combine both senior and junior debt into a single tranche and are traditionally provided by non-bank lenders across the segment.

To deploy capital more efficiently, private credit firms have had to look at the upper and lower ends of the space.

SLIDING SCALES

The lower middle market is a haven for many smaller direct lenders and investors seeking better documentation terms. With competition less intense, many of these loans can offer better lender protections.

"There are stricter underwriting standards in the lower middle market – the level of competition is a key factor, and you see less of it in this space," said Tas Hasan, partner at Deerpath.

Lower middle market deals, for instance, distinguish themselves from the upper segments because they still include a fixed-charge coverage ratio and capital expenditure limit.

In deals with companies that have an Ebitda of less than US$15m, 33% of transactions have a fixed-charge coverage ratio and capital expenditure limit, according to a report from law firm Proskauer. But higher-up, these protections become less frequent.

In deals involving companies recording an Ebitda of US$30m or above there are no capital expenditure restrictions, Proskauer data shows.

"Deals involving companies with an average Ebitda of a US$10m-US$15m all have the leveraged covenant, fixed-charge coverage, and Capex restrictions," said Tom Hall, managing director and co-head of private credit at asset manager Capital Dynamics.

"After that, it becomes a sliding scale, and lenders become comfortable with just a leverage covenant, and that gets looser at the upper end of the middle market. As companies grow above US$30m-plus cash flow, the market has decided that covenants have become less important," he added.

BUILD AND GROW

The lower middle market is not as penetrated by private equity sponsors as the core middle market, hence why banks continue to flourish in a segment where borrowers seek lower leverage and are more comfortable with lower pricing.

For some financial sponsors, however, buying into the lower middle market can be part of a long-term plan to expand a business aggressively through add-on acquisitions.

These cases work for private credit firms, which are keen to offer higher pricing in exchange for the flexibility desired by sponsors and are happy to deploy capital into a growing business through delayed-draw term facilities. rivate credit firms also need the extra yield compared with banks to compensate for the higher capital costs.

"Private equity funds embarking on systematic growth through acquisitions is a great strategy for a private credit fund," Hasan said. "We're happy to support bolt-ons and to fund acquisitions.

"For private credit funds at the lower end of the market, investing further capital into a single company can heighten the risk for funds, which are much smaller than core middle market funds.

Saratoga Investment Corp, a lower middle market lender, had investments in ice rental company Easy Ice and inventory management software company Censis, and added to its position over multiple years. This raised concentration issues for the firm – though it reported exiting both positions in its recent earnings call in January. Saratoga could not be reached comment.

Michael Grisius, chief investment officer at Saratoga, said in the firm's January earnings call that it wants to remain focused on the lower middle market.

"We have concentration limits related to industries and portfolio company position size as it's important to maintain diversity – taking an outsized position can negatively impact the portfolio down the line," Hasan said.

But the smaller nature of the companies can mean they are a riskier proposition with alternative capital solutions limited; and they are more vulnerable to broader macro-economic factors.

"If you have a US$10m Ebitda company and that loses US$1.5m in Ebitda, then that can be scary," said Ted Swimmer, head of corporate finance and capital markets at Citizens Bank.



About Deerpath Capital

Deerpath Capital Management, LP is a leading provider of senior debt financing to US lower-middle-market companies. Since inception, Deerpath has completed 400+ investments, deploying $3.3bn across a broad range of investment products and transaction types. Visit www.deerpathcapital.com to learn more.

Direct lenders around the world are talking with borrowers about easing interest payments, waiving penalties and relaxing covenants as they assess the growing damage to their portfolios caused by the coronavirus pandemic.

The discussions are occurring as the global turmoil seeps into the $812 billion private market. The crisis is one of the first major tests for the asset class, which has grown from about $200 billion before the 2008 financial crash -- buoyed by investors including pension funds, insurers and family offices.

The current upheaval is triggering a torrent of revolver draw requests, and forcing direct lenders to decide just how flexible they can be on already existing credit facilities.

"We're having some high-level conversations about making some temporary allowances," like relaxing interest payments or waiving covenants, said Antonella Napolitano, global head of investor relations at middle-market lender Deerpath Capital Management."We will evaluate these on a case-by-case basis. We are a reasonable lender, but at the end of the day we need to protect investor capital."

Globally, there is some $339 billion of middle-market debt outstanding to the most virus-sensitive sectors, including autos, airlines, drugs and textiles, according to UBS Group AG strategists.

Discussing Options

In North America, at least a dozen direct lenders are considering or have agreed to specific concessions such as switching to alternatives to cash for interest payments or relaxing pre-payment penalties, according to people familiar with the matter. Some who work primarily with private equity-backed companies are resisting making any changes like considering relaxing payments or waiving future covenants unless the firm's sponsors put in more capital or provide fund guarantees, said the people, who aren't authorized to speak publicly.

Toronto-based Bridging Finance has already granted a request from at least one borrower to switch to payment-in-kind interest, according to founder David Sharpe.

"We are open to working with our borrowers and looking at accruing interest if required to get through this period," Sharpe said. "We are non-distressed lenders."

The requests are even filtering down to those who provide financing to small corporate borrowers, like lower-middle market lender JB Capital.

"For anybody that's taking a hard line, whether it's a mortgage company or a private credit line, not giving some degree of flexibility, there's probably a special place in hell for those guys," JB Capital founder Jeremy Hill said.

Ares, Tikehau

In Europe, similar requests from borrowers facing liquidity crunches are flooding in.

Ares Management, the $149 billion alternative asset manager, is "working with our U.S. and Europe portfolio companies, and their sponsor owners, to determine how we can be supportive with their liquidity needs to keep their businesses operating," said Michael Dennis and Blair Jacobson, co-heads of European credit at the firm, in an emailed statement.

As of this week, French alternative investment firm Tikehau Capital has been asked for waivers by two companies heavily impacted by local lockdowns, the firm's head of private debt Cecile Mayer-Levi said.

"Zero revenues is something unheard of and difficult to cope with," Mayer-Levi said."Depending on the situation we'll be supportive, and play our role as a stakeholder alongside shareholders."

About Deerpath Capital

Deerpath Capital Management, LP is a leading provider of senior debt financing to US lower-middle-market companies. Since inception, Deerpath has completed 400+ investments, deploying $3.3bn across a broad range of investment products and transaction types. Visit www.deerpathcapital.com to learn more.

Every month, we will feature an active member of the ACG New York community in a brief interview. Reflecting industry insight and personal perspective, this feature will introduce industry leaders and offer advice on the tools you need to succeed in the ever-changing middle market.

1. Quick basics- role/firm/focus/how long have you been an ACG member?

I am a Managing Director and Co-Head of our Origination team at Deerpath Capital, a leading provider of customized, cash flow-based senior debt financing to lower middle market companies across diverse industries. Deerpath is headquartered in New York, with offices in Los Angeles, Boston, Ft. Lauderdale, and Chicago. Deerpath invests between $15 million to $50 million in companies that are typically financial sponsor-backed and/or owner-operated, with revenues of $10 million to $200 million. As a senior investment professional leading national origination for the firm, I'm the primary point-person with our private equity and investment bank relationships nationwide. I have been an ACG member since 2012.

2. What do you think are the biggest obstacles in the middle market today?

I think one of the biggest concerns in the middle market is the sheer influx of new capital that has flooded the market over the last several years. This has resulted from an increased number of participants entering the U.S. direct lending market as well as existing participants raising substantially larger funds. This crowed playing field has resulted in all-time high company valuations. The challenge now is how to separate ourselves from the pack and remain differentiated in terms of our products and offerings.

3. How has ACG helped you in your career?

Being a member of ACG has been extremely valuable for me and my firm. ACG has enabled me to develop new relationships and re-engage with old relationships which is a pivotal part of my role at Deerpath. It's really allowed me to develop a large network of both professional contacts and friends, so that I can continue to leverage each ACG member's business skills and services. ACG has provided a platform for me to engage with a spectrum of industry leaders across private equity, banking, consulting, etc., which has helped me grow my business and be successful in my career. Events held by ACG New York and across the country have allowed me to enhance Deerpath's presence in not only the local market here but across the country as well. ACG is one of my most important resources in developing networking contacts, which I find invaluable at this stage.

4. Can you tell us about your greatest success story/ proudest achievement?

I'm very fortunate to be able to work with a group of experienced, intelligent and collegial professionals at my current firm. Professionally, one of my most rewarding successes and achievements has been the opportunity that I've been given to build our origination platform nationwide at Deerpath—building something that we feel is sustainable and will provide long-term opportunities for our firm. So, outside of one particular investment financing opportunity, it's really is the ability to grow our origination and sourcing platform, and to have Deerpath in conversations within the lower middle market on a consistent basis.

5. What changes do you foresee happening in the middle market in the next 3-5 years?

It's very difficult to predict the next five days, never mind the next five years. Historically, there have always been pullbacks, some deeper than others. I think the middle market is here to stay but there will likely be a correction when the next recessionary period hits. That is why we are building a portfolio with ample downside protections in place to be able to withstand economic headwinds.

I think private equity and private debt will remain a valuable resource for corporate growth and development over time. Further, I believe the creative aspect in structuring deals will be contingent on the ongoing availability of capital and ample sources of opportunities in the market. I believe that having the capital available for financing and investing in the lower middle market will continue. The middle market is the life blood of the U.S.



About Deerpath Capital

Deerpath Capital Management, LP is a leading provider of senior debt financing to US lower-middle-market companies. Since inception, Deerpath has completed 400+ investments, deploying $3.3bn across a broad range of investment products and transaction types. Visit www.deerpathcapital.com to learn more.

Antonella Napolitano, head of investor relations at Deerpath Capital, and Gabriella Kindert, member of the supervisory board at Mizuho Europe, join OMFIF's Julia Demidova. They discuss the growing investor appetite for private debt, as well as the increasing importance of environmental, social and governance principles.



About Deerpath Capital

Deerpath Capital Management, LP is a leading provider of senior debt financing to US lower-middle-market companies. Since inception, Deerpath has completed 400+ investments, deploying $3.3bn across a broad range of investment products and transaction types. Visit www.deerpathcapital.com to learn more.