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Private Credit

Lower-mid-market PE shop expands into private credit amid regional bank retreat

A boutique PE firm recently launched a private credit business to capture rising corporate lending opportunities in the lower middle market.

LongWater Opportunities, a lower-middle-market private equity firm, has rolled out a private debt strategy that seeks to capitalize on the continuing rise in lending to smaller companies.

The firm’s new venture comes as traditional bank lenders pull back from lending to the lower middle market, cutting off those borrowers’ access to credit and creating space for private credit providers to step in.

“There has been a pullback in credit opportunities and credit offerings in the lower middle market,” said Kevin Prunty, who was hired to lead LongWater’s newly minted private credit arm.

Regional banks have been struggling with deposit losses, more costly funding sources and other challenges. A number of those banks posted weak quarterly earnings and unveiled plans to shrink their balance sheets. Those reporting double-digit drops in third-quarter profits include KeyCorp, Truist Financial and Citizens Financial, which have all announced steps in recent quarters to shrink their lending businesses and trim costs.

While these capital providers grapple with disappointing earnings and downsizing, demand for credit has strengthened among businesses in the lower middle market, said Jordan Bastable, a partner at LongWater.

A survey released this month by accounting adviser RSM US showed a sharp drop in recent years in the number of middle-market firms relying on traditional bank lending for cash. Only 56% of firms in the survey sought bank lending in the past 12 months, down from 74% in 2015. In addition, more than half of respondents said they would be less inclined to seek loans from commercial banks.

Because of the imbalance in credit demand and supply, private lenders are able to command greater risk premiums on credit facilities offered to those businesses. Spreads on lower-middle-market deals have increased by 100 basis points to 200 basis points during the last 12 to 18 months, according to Prunty.

At the same time, lenders have been closely watching borrowers’ ability to service debt. They are paying more attention to financial covenants that measure companies’ cash flow. Chief among them is the fixed-charge coverage ratio, which reveals whether a company can generate enough cash flow to cover its debt payments and other fixed charges, Prunty said.

LongWater’s private credit business intends to provide senior and junior debt to companies in the lower middle market—companies with EBITDA of $3 million to $15 million. The lender will also make preferred equity investments, but that won’t be its primary focus. LongWater hired eight investment professionals from Reinsurance Group of America to run the business.

In addition to private credit, LongWater also runs a private equity strategy, its bread-and-butter business since its formation in 2009. The PE team currently manages $300 million in assets and has raised three buyout funds that primarily target industrial and manufacturing companies in the lower middle market.

Featured image by RF Pictures/Getty Images

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