Direct Lending: Attractive economics in a shifting environment

Key takeaways

• Direct lending economics have improved: Higher US base rates and wider spreads have increased prospective yields for newly originated loans.

• Stronger economics don’t necessarily mean greater risk: Lenders can benefit from tighter underwriting, stronger documentation and enhanced lender protections.

• Selectivity remains critical: Resilient borrower fundamentals—particularly among larger companies—reinforce the importance of disciplined underwriting and manager selection.

A reset in US interest rate expectations and widening of credit spreads have shifted the direct lending dynamics for investors. In turn, we believe private credit has become increasingly attractive over the course of this year.

Multiple drivers of yield enhancement

At the start of 2026, market participants broadly anticipated multiple US interest rate cuts, and the forward curve would suggest a SOFR level of approximately 3.2% in the second quarter of 2027.¹ However, persistent inflation and a more resilient economic backdrop have materially altered the outlook, with forward markets now implying that US rates could rise north of 4.6% by mid-2027.¹ As a result, private credit strategies, which typically feature floating rate structures, are well-positioned to benefit from a prolonged ‘higher-for-longer’ rate environment.

Exhibit 1: SOFR base rates and forward curve

Importantly, the improvement in yield expectations is not solely a function of higher US interest rates. Credit spreads have also widened as lenders have become more selective amid elevated market uncertainty.² While dry powder remains relatively accessible, we believe underwriting standards have tightened, and lenders are demanding greater compensation for risk, resulting in more attractive economics on newly originated transactions. In our view, the combination of higher US base rates and wider spreads has meaningfully enhanced prospective yields across the asset class.

New investments in focus

These dynamics have driven a significant increase in expected returns for new investments. Gross asset yield expectations have risen from approximately 8.5% at the beginning of the year to ~10% today, representing one of the most meaningful improvements in direct lending economics in recent years.^1,3 For investors seeking income –oriented strategies, we believe the current market offers an attractive opportunity to deploy capital at yields that are substantially higher than those available just months ago while maintaining exposure to senior, floating-rate assets.

Exhibit 2: Potential all-in gross yield

The current backdrop is especially compelling, in our view, because the potential for enhanced yield can still be achieved while maintaining disciplined underwriting standards. In our view, heightened uncertainty has encouraged private credit managers to focus on resilient businesses, conservative capital structures, and enhanced lender protections. As a result, many newly originated transactions are offering higher yields alongside improved documentation, tighter covenant packages, and greater downside protection than was available during the more competitive lending environment of recent years.³

Furthermore, we believe this represents a particularly attractive environment because improved gross yield potential is being driven by stronger market fundamentals rather than increased risk-taking. Borrowers continue to place significant value on the speed, certainty, and flexibility of private capital that is often unavailable in public markets, enabling lenders to maintain disciplined underwriting standards while capturing higher yields and enhanced downside protections.

Larger companies continue to remain attractive

Borrower fundamentals, particularly for larger, well-established companies, continue to remain resilient.⁵ Bigger businesses often benefit from diversified business models, strong free cash flow generation, and enhanced financial flexibility, which can help them to better navigate higher interest rate and uncertain macroeconomic environments than smaller issuers. In our view, this has created favorable market conditions for private credit managers focused on upper-middle-market businesses, where credit performance has been resilient.⁵

Exhibit 3: Year-over- year last twelve months’ EBITDA growth by company size (Based on EBITDA)

Record institutional fundraising

Institutional investors appear to be increasingly recognizing the attractiveness of the private credit opportunity set. According to Preqin, direct lending drawdown funds raised a record $72 billion in the second quarter of 2026, underscoring what we believe to be continued institutional conviction in both the durability and long-term value of the asset class. In contrast, repurchase requests across ten of the largest non-traded BDCs reached an average of 9.9% of shares in the second quarter following a sharp increase over the prior three quarters.⁶ In our view, this divergence highlights a distinction between institutional investors, who remain focused on the asset class's underlying fundamentals and improving return profile, and portions of the wealth channel, where flows have been more heavily influenced by short-term market headlines.

Exhibit 4: Aggregate fundraising for direct lending funds

Conclusion

While market conditions will inevitably evolve, we believe today's environment highlights the value of disciplined capital deployment and rigorous credit selection. Taken together, the current combination of enhanced income potential, resilient borrower fundamentals, and sustained institutional demand supports a highly constructive outlook for direct lending and what we believe is one of the most attractive vintage opportunities in recent years.

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