Why Private Credit's Been Booming Even as Interest Rates Go Up

Episode Summary

Executive Summary: The episode explains how private credit has grown into a trillion-dollar market rivaling junk bonds, and why it has remained resilient despite higher interest rates and tighter public markets. Guest Laura Holson of New Mountain Capital outlines what private credit is, why sponsors prefer direct lending, how deals are sourced and structured, and why illiquidity, relationship-based underwriting, and sponsor equity cushions may reduce defaults.

Main Topics: What private credit is (Priority: 5/5): Private credit is privately originated debt not intermediated by banks or traded publicly, spanning direct lending, opportunistic debt, distressed debt, and real estate financing. Why the market has boomed (Priority: 5/5): The market has expanded rapidly and now rivals the broadly syndicated junk bond market, helped by floating-rate coupons, investor demand for yield, and execution advantages over public markets. Deal structure and sponsor appeal (Priority: 5/5): Direct lending offers certainty of execution, simpler documentation, fewer intermediaries, and more flexible, relationship-based negotiations than syndicated loans. Resilience through higher rates (Priority: 5/5): Despite sharp rate increases, private credit has held up better than expected because many borrowers are asset-light, cash-generative, and backed by substantial equity. Risk, liquidity, and defaults (Priority: 4/5): The conversation weighs whether lower observed defaults reflect genuine resilience, club lending discipline, or simply illiquidity and less frequent mark-to-market pricing. Market share shift from banks to private lenders (Priority: 4/5): Banks have responded by building their own direct lending capabilities, but private credit continues to gain share as refinancings and maturities roll over from syndicated markets. Regulation and leverage limits (Priority: 3/5): Private credit remains less levered than banks and many structures are term-matched, but the asset class may face more regulatory attention as it becomes more institutionalized.

Key Arguments: Private credit is best understood as privately originated, mostly unrated debt that can sit anywhere in the capital structure and includes more than just direct lending. The asset class has grown to roughly the same size as the junk-rated corporate bond market, showing how significant it has become in modern credit allocation. Higher policy rates did not break the market because many direct loans are floating rate and borrowers often have strong equity sponsorship and recurring cash flow. Direct lending is attractive to sponsors because it provides certainty of execution, avoids the volatility of bookbuilding, and can simplify capital structures. Club deals with a small group of lenders improve communication and flexibility compared with large syndicated lender groups. Lower default losses in private credit may reflect genuine structural advantages: closer lender-sponsor relationships, more bespoke workouts, and higher sponsor incentives to support businesses. Illiquidity may contribute to apparent resilience because private assets are not marked continuously, but the guest argues fundamentals and structure matter more. The looming maturity wall in syndicated credit should create refinancing opportunities for private credit to continue taking market share. Bank responses include building their own direct lending businesses, effectively competing with their own origination clients. Regulatory concerns exist, but private credit is generally less levered than banks and often uses permanent or term capital, limiting systemic risk compared with highly levered financial institutions.

Data Points: Private credit market size: $1.3 trillion to $1.6 trillion outstanding - Estimate cited for the size of the private credit market Junk bond market size: About $1.3 trillion to $1.4 trillion outstanding - Comparison used to show private credit is now roughly as large as the syndicated junk bond market New Mountain credit platform AUM: Nearly $9 billion - Size of Laura Holson’s credit platform New Mountain company count: 45 companies - Private equity portfolio companies used as a source of sector expertise New Mountain investment professionals: Over 150 - Team size supporting sector research and underwriting Private equity dry powder: About $580 billion - Estimate of undeployed capital available to private equity sponsors Private credit dry powder: About $100 billion - Approximate undeployed capital in private credit mentioned during discussion Bank leverage limit for BDCs: Max 2x debt-to-equity - Regulatory leverage cap for business development companies Typical capital structure example: $300 million debt / $700 million equity - Illustrative sponsor-backed deal used to show equity cushion Interest expense increase example: $3 million per 1% rate increase - Example for a $300 million debt tranche in a $1 billion capital structure Interest expense increase example at 5%: $15 million annually - Example if rates rise 5% on the same $300 million debt tranche Base-rate spread range: SOFR +525 to +700 - Approximate range for unitranche loan spreads over the past 10 years Leveraged loan default rate: 1.4% to 4% - Joe cites a rise in default rate in the broadly syndicated leveraged loan market Maturity wall: Nearly $1 trillion due by end of 2026 - Syndicated debt coming due, which the guest says should help private credit

Pivotal Quotes: "It's debt that is privately originated... not intermediated by a bank, but that's also not traded on any kind of public market." — Laura Holson: Her definition of private credit "We used to be 100% syndicated... then maybe five or so years ago, it was probably about 50-50. And now we're doing pretty much exclusively only direct lending deals." — Laura Holson: Her description of market share shifting toward direct lending "If you think about a billion dollar capital structure that's financed with $300 million of debt, and $700 million of equity... if you have interest rates go up by 1%, that's an extra $3 million of interest expense." — Laura Holson: Illustration of why sponsor-backed companies can absorb higher rates

Implications: Private credit appears to be structurally reshaping corporate financing, especially for sponsor-backed borrowers. If public credit remains volatile, the direct lending market may keep gaining share, though investors should watch for liquidity, regulatory scrutiny, and deterioration in weaker credits.