In Brief
- Tighter post-GFC rules and higher capital requirements have reduced bank lending to small and mid-sized companies, creating room for private credit to fill the gap.
- Private credit fundamentals have remained broadly resilient since COVID, with low default rates and manageable pockets of borrower stress despite higher rates.
- Floating-rate structures tied to SOFR have supported higher yields as rates rose, with covenants and recoveries improving the risk profile even as competition compresses spreads.
Changes to regulations have shifted income opportunities to private markets.
From an increase in post-GFC banking rules to heightened capital requirements, regulatory shifts have constrained banks' ability to lend to small and mid-sized companies.
As banks retreated in the lending space, private credit have stepped in to fill the gap, growing to a $2 trillion market that spans across direct lending and other credit segments. This has meaningfully redirected opportunities toward private markets, especially for income-seeking investors.
Fundamentals remain sound.
Since recovering from the COVID downturn, private credit default rates have remained low, broadly tracking those of publicly traded leveraged loans and high-yield bonds. While rising interest rates since 2022 have introduced some borrower stress — reflected in increasing payment-in-kind income across rated portfolios — and distressed exchanges have picked up in the leveraged loan market, these remain manageable.
Overall, credit quality across private credit portfolios has held relatively resilient, suggesting fundamentals remain on solid footing.
Private credit provides compelling yields.
With most direct lending structured at floating rates tied to SOFR, this means that yields rise alongside interest rates, as seen since 2022. Stringent covenants and higher recovery rates further enhance the risk profile relative to high-yield bonds.
While spread compression from increased competition and investor demand has tempered returns somewhat, direct lending yields have continued to outpace leveraged loans, rewarding investors for accepting illiquidity premiums.