Private credit defined1
Private credit refers to directly originated debt investments that are illiquid and not actively traded in the debt markets. These investments may be debt to a company or a pool of assets. Private credit provides a way for businesses to access credit and growth capital, often when traditional sources of capital are not available or borrowers are seeking additional flexibility. In many instances, private lenders will bundle a collection of direct loans into a private credit fund. Investors in such funds are typically seeking to achieve consistent income with lower price volatility and lower credit and interest rate risk than public fixed-income investments.
The five realities of private credit
#1 Direct lenders are meeting an important need in the economy.
In recent decades, as a result of the consolidation of the banking industry, traditional banks have significantly reduced the amount of capital they lend to middle market companies, focusing on larger borrowers instead. This has left the middle market, often considered the heartbeat of the U.S. economy, without a steady source of debt funding needed to grow. The private credit markets broadly—and direct lending in particular—have stepped in to fill the gap and have steadily taken market share from traditional bank lenders.
Banks represent a dwindling share of U.S. primary commercial loan issuance
#2 Private credit has demonstrated lower credit risk.
Non-bank lenders generally issue loans that they intend to hold to maturity, not repackage and sell to others. Therefore, they are more likely to conduct extensive due diligence before extending credit to a company. This has resulted in historically lower default rates relative to public fixed income.
Long-term average default rates (2005–2023)
#3 Private credit has historically provided stronger risk-adjusted yields.
Since 2005, private direct lending has generated a 510bps spread to the leveraged loan market while generating nearly identical annual loss rates.2 Relative to high yield bonds, private direct lending has yielded 380bps of additional spread with 31% lower annual loss rates.2
Asset yield and loss comparisons
| Annualized since 2005 | Private Direct Lending | Leveraged Loans | High Yield |
|---|---|---|---|
| Gross asset yield | 10.9% | 5.8% | 7.6% |
| Loss rate | 10.2% | 0.94% | 1.48% |
| Net asset yield | 9.9% | 4.8% | 6.1% |
#4 Private credit has provided protection against interest rate risk.
Due to the largely floating-rate nature of private credit investments, they are typically less sensitive to changes in interest rates than public fixed income. Floating interest payments are reset to a reference interest rate every 30 to 90 days. As rates rise, investors receive more income while prices stay stable.
Floating rate debt demonstrates less price sensitivity than public fixed income
#5 Private credit has typically exhibited greater price stability.
Direct loans tend to be held by investors who originate the debt as a longer-term investment, rather than trading it frequently. As a result, private credit has typically exhibited greater price stability than public market equivalents while maintaining similar levels of return. This reduced mark-to-market volatility can induce less perceived need to trade and can make these investments easier to hold for the long term.
U.S. floating rate direct loans have been less volatile than public fixed income
An enduring shift toward private credit
Many of today’s highest-growth businesses are seeking non-bank lenders to provide the capital they need for continued success. Middle market companies, most of which are private, are fundamental to economic growth. The owners of these businesses appreciate the long-term focus of direct lenders as well as the closer alignment of interests between their company and its creditors. The structural shift from public to private capital is expected to continue, fueled by the increased reliance of private equity sponsors on direct lending.
Why is private credit playing an increasingly important role in individual investors’ portfolios?
Private credit has delivered superior yields over time
