Direct Lending is a form of corporate debt provision in which lenders other than banks make loans to companies without intermediaries such as an investment bank, a broker or a private equity firm. In direct lending, the borrowers are usually smaller or mid-sized companies, also called mid-market or small and medium enterprises, rather than large, publicly listed companies. Lenders are generally asset management or private debt fund manager firms. Direct lending funds use leverage, but generally less than banks or collateralized debt obligation funds (CDO/CLO).[1]
Private Debt primarily focuses on investing at the top of the capital structure, primarily in senior, secured first lien debt. Investing at or near the top of the capital structure reduces risk relative to equity. Direct Lending includes Senior Debt and Unitranche Debt. Quarterly interest payments drives a constant cash flow stream throughout the deal life. Because the total AUM of both Private Equity and Private Credit exhibited strong growth from 2013-2023, the proportion of Private Credit has remained relatively steady for the past decade. The assets under management (AUM) in Private Credit has grown by almost 4 times over the past decade. Private Credit metrics are proxied by Direct Lending which has exhibited strong performance through economic cycles. CalPERS references a Direct Lending benchmark as represented by the Cliffwater Direct Lending Index[2] having market size of $263 billion as of December 2022.[3]
The market has grown in importance since around 2009 in response to banks reducing their lending activities to companies in the wake of the Financial crisis of 2007-08.[4] The need for direct lending has been put at €100 billion in Europe alone between 2013 and 2015.[5] However, other sources report that in 2014 asset managers are struggling to find enough direct lending opportunities to invest in.
Asset managers cite the higher returns available from direct lending strategies as a main reason that people should invest in direct lending. US pension funds are among the investors who are reported to have made allocations to direct lending strategies, especially in Europe. Several European governments have taken initiatives to boost direct lending to smaller companies since the financial crisis. For example, in 2012, the UK government introduced a scheme to lend £700 million of public money to smaller companies in partnership with asset managers.
2018 U.S. data shows performance returns for private credit funds equal or better than leveraged-loan, high-yield and BDC indexes. Direct lending funds have relatively low beta with positive alpha when benchmarked to leveraged loan/high yield indices. Low correlation is observed between direct lending funds with leveraged loan/high yield indices.[6]
A large number of asset management firms have started funds to invest in direct lending,[7] and several US firms have targeted European direct lending since around the start of 2013.[8]
