The private credit market—particularly corporate direct lending—has expanded significantly in recent years, prompting some investors to question whether such growth is sustainable. In our view, two concepts can hold true at the same time: 1) the market for private credit has the capacity to support continued expansion of the asset class, and 2) investors should remain attentive to emerging risks when selecting a private credit manager. Below, we’ve highlighted several considerations regarding the growth of private credit.

Each Subcomponent of Leveraged Credit Has Experienced Growth Over Time

In 2010, the value of private corporate loans totaled $310 billion. Today, that number has reached $1.7 trillion, now roughly one third of the overall leveraged credit market. For context, the high yield bond market began to develop as a stand-alone asset class in the 1970s. Initially, high yield bonds were born from downgraded investment-grade bonds, or “fallen angels.” Over time, we began to see bonds that were newly issued as below investment grade. That market, which started from virtually nothing, has grown to nearly $1.5 trillion, shown in Figure 1.

Today, both high yield bonds and leveraged loans are commonly used as a tactical or strategic allocation in client portfolios. Private corporate loans with floating coupons have served as another source of financing and liquidity for corporations and have experienced similar growth over time, reaching a size comparable to the other two subcomponents of the leveraged credit markets and becoming more widely considered as a strategic allocation in fixed income portfolios.

Private Credit Growth Has Been Amplified by a Transfer of Risk

Middle market companies have existed for a very long time. These borrowers needed financing twenty years ago and they continue to need financing today. We estimate that the middle market is made up of nearly 200,000 companies that represent one-third of the private sector gross domestic product (GDP) and would rank as the 4th largest economy in the world behind the US, China, and Japan. In the past, it was largely regional/commercial banks doing the lending, however, due to banking consolidation, larger banks prefer to arrange financing for larger companies, thereby generating higher fees. Banking regulation has also altered the lending landscape as capital requirements have made banks less willing and able to make those same loans. As a result, non-bank lenders are filling the void. To be sure, this is not new risk, instead it’s a transfer of risk from banks to asset managers and their clients.

What’s more, it’s also a transfer of risk from the liquid public high yield and bank loan, also known as leveraged loan, markets to private markets as larger borrowers who have historically and exclusively financed themselves through the capital markets are now using the private credit option. COVID-19 and the regional banking crisis following the failure of Silicon Valley Bank in 2023 also supercharged growth in private credit. In both instances, public capital markets retreated; companies that still required financing, including larger firms that had historically borrowed in the public markets via large investment banks, turned to private markets for capital, indicated by the increase in $1 billion private credit deals over the last few years in Figure 2.

Private Credit Has Demonstrated Compelling Risk-Adjusted Returns

Beyond this risk transfer, another reason for this rapid growth in private credit has been the undeniably attractive risk-adjusted returns the asset class has delivered over time. Characterized by high income and lower volatility, private credit (and direct lending in particular) has demonstrated a favorable risk-reward profile relative to liquid credit.

The Democratization of Alternatives

Furthermore, the proliferation of innovative, semi-liquid vehicles such as interval funds and business development companies (BDCs) has offered individual investors greater access to the asset class that was once almost exclusively institutional in nature. 

Manager Selection Matters

We tend to think about corporate direct lending as one ecosystem and historically that was the case. Congress created Business Development Companies (BDCs) in 1980 to stimulate investment in small- and mid-sized companies. Therefore, direct lending was defined as private loans by non-bank lenders to middle market companies. But as legacy BDCs have grown in size, the ecosystem split into two: the historic one and one focused on lending to larger companies that also have access to the capital markets for financing. Many of the “bubble” concerns investors have reside in the latter. 

Larger BDCs with significant assets under management have sizeable amounts of cash to put to work, sourced from both inflows and loan repayments each year. These larger managers have to reinvest tens of billions of dollars every year. As a result, they have grown too large to make smaller loans to middle market companies, causing them to migrate out of the core middle market and make loans to larger capitalization borrowers.  Additionally, the deployment of excess cash calls into question how prudently they are allocating that capital and introduces legitimate concerns such as greater exposure to broadly syndicated loans (BSL), higher leverage, weaker covenants, smaller illiquidity premiums, and the potential for liability management exercises (LME) to creep into their books. The concept of covenant-lite (cov-lite) loans has saturated the large capitalization (cap) broadly syndicated loan market for over a decade as well as the larger end of the private credit market. However, private loans to mid-sized companies are characterized by stronger covenants with greater lender protections.

Additionally, many legacy managers are holding older, less ideal vintages originated in 2020 and 2021 when base rates were zero. Many of these loans were not underwritten with an expectation of a 500+ basis point (bp) rise in the secured overnight financing rate (SOFR). This significant increase in borrowing costs has pressured credit metrics (such as interest coverage ratios) and increasing risk to investors in these older vintages.

At Lord Abbett, we see value in scaled organizations with a long history and strong foundation in credit that employ managers with multi-decade of experience in private lending. Additionally, the importance of patient lending has been elevated. Platforms with the right amount of available capital can employ a more selective process relative to those teeming with assets, inflows, and maturing loan proceeds. We believe a focus on senior secured, first lien loans to middle market borrowers allows investors to gain exposure to the grassroots of the asset class versus those financing large corporations.  We believe a conservative approach to direct lending that emphasizes low loan-to-value (LTV) ratios and healthy interest coverage is prudent in today’s environment. We also think that vintages originated after the 2022 Fed rate hikes could potentially offer more resilient structures, particularly in non-cyclical or defensive sectors.

Drivers of Future Growth:

Higher interest rates have diminished private equity (PE) firm exit activity, resulting in a large backlog of unrealized assets that will need to be sold in the near term to return capital to investors. By the end of 2024, over 30% of private equity backed companies had been held by fund managers for at least 5 years, the highest percentage in nearly a decade. As firms have been in a holding pattern, private equity dry powder has reached $2.7 trillion, according to Preqin (see Figure 6).  However, exit activity has already started to pick up and is expected to accelerate as interest rates decline, cash flows improve, and valuation mismatches between buyers and sellers begin to shrink, setting the stage for a rebound in mergers and acquisition (M&A) transactions. As most new buyouts are financed with a 1:1 debt-to-equity ratio, this PE dry powder should eventually result in the need for a significant amount of debt financing, including private credit. We expect that these sale processes will lead to consistent and growing demand for new private credit investment opportunities to support these buyouts. 

Closing Out

The evolution of private credit represents one of the most transformative developments in modern fixed income investing. As the asset class continues to mature, it is reshaping how capital is intermediated between borrowers and investors - offering enhanced yield potential, portfolio diversification, and a compelling alternative to traditional public markets. Yet, as with any rapidly expanding market, the importance of rigorous manager selection, disciplined underwriting, and thoughtful portfolio construction cannot be overstated. For investors, we believe the opportunity set offered in private credit remains robust, supported by strong structural demand, favorable supply dynamics, and durable income characteristics. With prudent oversight, the next phase of growth in private credit may not simply be about expansion, but about endurance - anchored in quality, selectivity, and long-term value creation.