Lower middle market companies could become the next mega-issuer in private credit. But sourcing a smaller company with this potential may be as challenging as finding a four-leaf clover. In a recent Pitchbook article, Ted Denniston, Senior Managing Director and Co-Head of NXT Capital, discusses NXT Capital’s approach to the lower middle market, leverage improvement among smaller borrowers, and his outlook on deal volume and quality for 2024.
Key Insights from Ted Denniston:
- “NXT budgets roughly a 2% default rate, and we’ve been running at about that level for the last 14 years. Our recovery rate exceeded 85% last year, and I feel it’s due to the covenant protection we have on these deals. It gets us to the table earlier.”
- “It’s a sliding scale. We see about one turn lower leverage for businesses with sub-$15 million in EBITDA, and a half turn lower leverage once businesses reach $20-$25 million in EBITDA.”
- “I think deal volume will be up compared to last year, and quality will be strong. The quality of deals we are seeing now are businesses that have adjusted to the higher interest rate environments, and given where the market is at, we’re able to put less leverage on these deals compared to two years ago.”
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