How does direct lending work in private credit, and what risk-return profile should investors expect compared to broadly syndicated loans?

Direct lending involves non-bank lenders (typically private credit funds) originating loans directly to middle-market companies without intermediation by banks or syndication desks. It has grown dramatically since the 2008 financial crisis as banks retreated from smaller borrowers under tighter regulation.\n\nStructural Comparison:\n\n| Feature | Bank Loan | Broadly Syndicated | Direct Lending |\n|---|---|---|---|\n| Borrower size (EBITDA) | >$100M | $50M-$500M | $10M-$75M |\n| Number of lenders | 1 | 10-30 | 1-3 |\n| Negotiation | Limited customization | Standardized docs | Highly negotiated |\n| Covenants | Incurrence-based | Covenant-lite trend | Maintenance covenants |\n| Yield (spread over base) | +150-250 bps | +250-400 bps | +500-700 bps |\n| Liquidity | Moderate | Tradeable (CLO market) | Illiquid (hold to maturity) |\n\nWhy the Premium Exists:\n\nEverglen Capital manages a $2.4 billion direct lending fund. They recently originated a $45 million senior secured term loan to Hartwell Manufacturing (EBITDA: $28 million).\n\n- Coupon: SOFR + 625 bps (all-in yield approximately 11.5%)\n- OID (Original Issue Discount): 2 points (lend $44.1M, owed $45M)\n- Maturity: 5 years, amortization 1% per year\n- Covenants: maximum leverage 4.5x, minimum fixed charge coverage 1.2x, quarterly reporting\n\nComparable broadly syndicated loans at the time yielded SOFR + 375 bps. The 250 bps premium compensates for:\n1. Illiquidity: No secondary market, capital locked for 5+ years\n2. Complexity: Smaller borrowers require deeper due diligence\n3. Concentration: Single lender bears 100% of credit risk\n\nKey Risks:\n- Middle-market borrowers have less diversified revenue, thinner management teams, and limited access to capital markets for refinancing\n- Limited information: private companies lack public filings, analyst coverage, and audited financials in some cases\n- Workout complexity: when defaults occur, the direct lender manages the entire recovery process without a syndicate to share costs\n\nReturn Attribution:\nEverglen's fund generated a net IRR of 9.8% over its 2019 vintage. Decomposition: base rate (4.5%) + credit spread (5.5%) + OID amortization (0.4%) - defaults (-0.3%) - fees (-0.3%) = net 9.8%.\n\nExplore private credit structures in our CFA Alternative Investments course.