Direct Lending: A Durable Opportunity Amid Shifting Market Dynamics

Private credit has transformed from a niche alternative to a cornerstone of institutional and individual portfolios.

By Michael Occi

In the evolving landscape of private markets, direct lending has emerged as a resilient and attractive strategy for investors seeking yield and diversification. Even as asset yields have moderated from their recent highs, the asset class continues to offer compelling return potential, robust credit quality and a favorable supply-demand dynamic—especially in today’s “higher-for-longer” interest rate environment.

A Structural Shift in Private Credit

Over the past 15 years, private credit has transformed from a niche alternative to a cornerstone of institutional and individual portfolios. Global private credit assets have surged from $2 trillion in 2020 to approximately $3 trillion in early 2025, with projections to surpass $5 trillion by 2029. Direct lending, the largest segment within private credit, now accounts for roughly half of all invested value, with U.S. direct lending alone reaching $1 trillion—more than doubling since 2019—according to Pitchbook.

This rapid growth has prompted questions about whether lending supply has outpaced borrower demand. However, current market dynamics suggest the opposite: pent-up demand from private equity sponsors is poised to outstrip available direct lending capital, setting the stage for a favorable environment for lenders.

U.S. Private Equity Demand Set to Outstrip Supply 

The middle-market private equity segment in the United States, which relies heavily on direct lending for deal financing, is experiencing a resurgence in activity. After several years of subdued deployment due to higher interest rates and challenging exit conditions, U.S. private equity managers are now sitting on an estimated $546 billion in dry powder. When factoring in typical leverage, this translates to $910 billion in potential deal value—well above recent annual deployment levels.

At the same time, a significant “maturity wall” looms, with $475 billion in middle-market loans coming due over the next seven years, more than half of which will mature in the next four years. This results in an average annual refinancing demand of $66 billion, further underscoring the need for direct lending capital.

When combining buyout and refinancing demand, the total financing need for private equity middle-market borrowers is projected to reach $506 billion over a typical two-year deployment cycle. In contrast, the cumulative supply of direct lending capital—including both dry powder and expected evergreen fundraising—totals just $228 billion. This results in a demand-to-supply ratio of 2.2x, underscoring the potential for improved pricing power and excess returns for direct lenders.

Resilience Across Market Cycles

Direct lending’s appeal is not solely a function of supply-demand imbalances. The asset class has demonstrated consistent outperformance across market cycles, delivering superior risk-adjusted returns compared to both public credit and other private market alternatives. According to Cliffwater Direct Lending Index, since 2008, U.S. direct lending has generated average annual returns of 11.6% during rising-rate periods—two full percentage points above its long-term average.

Unlike fixed-rate bonds, most private credit instruments are structured with floating rates, providing real-time protection against interest rate movements and inflation. This feature proved critical during the Federal Reserve’s tightening cycle of 2022–2023, when, according to the Cliffwater Direct Lending Index, direct lending consistently delivered double-digit returns. Even as rates have begun to decline, yields remain elevated by historical standards, with all-in yields adjusting to approximately 9.2% following the most recent rate cuts.

Credit Quality Remains Solid

Concerns about credit quality in a higher-rate environment have so far proven unfounded. Default rates in direct lending, including restructurings, have trended lower since April 2024. and now sit below comparable rates in the broadly syndicated loan market. Meanwhile, EBITDA-to-interest coverage ratios for middle-market borrowers have improved, and consensus forecasts point to accelerating EBITDA in the first half of 2026. 

A lower interest rate environment could further benefit borrowers by reducing interest expense, while rising EBITDA levels support solid fundamentals. These trends suggest that direct lending is well-positioned to weather potential macroeconomic headwinds.

Conclusion: A Core Portfolio Allocation

Direct lending has firmly established itself as the financing market of choice for private equity middle-market borrowers and a core allocation for diversified investor portfolios. With powerful demand drivers, limited capital supply, and a track record of resilience across cycles, the asset class offers a potentially compelling opportunity amid uncertainty.

For investors seeking yield and diversification, the question is no longer whether direct lending deserves a place in portfolios—but how best to allocate.