Direct lending is the practice of non-bank financial institutions providing loans directly to companies, bypassing traditional bank intermediaries. It has emerged as the dominant strategy within private credit, accounting for over 60% of the market.
How Direct Lending Works
Direct lenders typically target middle-market companies—those with annual revenues between $10 million and $1 billion—that need financing for various purposes:
- Leveraged Buyouts (LBOs): Financing private equity acquisitions
- Growth Capital: Funding expansion initiatives
- Refinancing: Replacing existing debt with better terms
- Recapitalizations: Enabling ownership changes or dividend payments
Loan Structure
Most direct loans are senior secured, meaning they have:
– Priority in bankruptcy: First claim on company assets
– Collateral backing: Security interest in borrower assets
– Floating rates: Interest rates that adjust with benchmarks like SOFR
– Financial covenants: Requirements to maintain certain financial metrics
Risk and Return Profile
Direct lending typically offers:
– Returns: 8-12% annually
– Default rates: Lower than high-yield bonds historically
– Recovery rates: Higher due to senior secured position
Key Players
The direct lending market includes specialized funds managed by firms like Ares, Apollo, Blue Owl, and Blackstone, as well as business development companies (BDCs) that provide retail access to this asset class.
Market Dynamics
Direct lending has thrived due to:
– Banks reducing leveraged lending after Dodd-Frank regulation
– Private equity’s need for reliable financing partners
– Institutional investors seeking stable, yield-generating assets
– Lower volatility compared to public credit markets