Trends in corporate direct lending 1H25

Executive summary

Returns: Across both the US and European markets, returns remain attractive by historical standards, despite moderating tailwinds as yields decrease alongside base rates and spreads.

Pricing: Spreads continued to compress in 1H25. This was mainly driven by an imbalance between the demand and supply of loans within the direct lending market. High and persistent economic uncertainty may lead to wider spreads ahead, particularly in sectors vulnerable to tariffs and supply chain risks.

Credit metrics: Fundamentals are showing early signs of improvement, with interest coverage ratios beginning to recover as some central banks ease policy rates. Newly issued loans’ leverage levels have also stabilized. However, US middle-market companies saw lower earnings growth rates in early 2025 compared with previous quarters. Some sectors (e.g., consumer) were affected more than others.

Volumes: Lending fell in 1H25 relative to a very strong 4Q24 but was still solid by historical standards. However, if uncertainty persists, the muted M&A activity and delayed IPOs could hurt direct lending volumes.

Macro: The environment is shifting, with the gap between US and European growth projected to narrow by year-end—marking a potential end to the recent period of US economic exceptionalism. Rising policy uncertainty is weighing on US business confidence and consumer demand and contributing to a softer outlook. Inflation trends are diverging. As a result, the Federal Reserve (Fed) appears likely to hold rates steady through most of 2025, while the European Central Bank (ECB) may cut rates further to support growth.

Direct lending

Returns

Normalization of total returns after historically high cash income

Quarterly returns for US direct lending have decreased to a still-attractive 2.1% (Figure 1). This decline is primarily due to lower base rates and spread tightening since early 2024, which compressed income generation—the main driver of direct lending returns. Nonetheless, if the Fed maintains its policy rates through the summer (as many expect it to), direct lenders could see income stabilize through 2H25.

Realized and unrealized losses

Increase in impairment charges in BDCs but realized losses are stable 

Trailing 12-month unrealized losses in BDCs turned negative for the first time since 2023, registering at -0.4% in 1Q25 (Figure 2). This suggests that managers are taking a more cautious approach, proactively marking down the positions they view as most vulnerable amid shifting macroeconomic conditions. This level of unrealized losses, however, is not unusual from a historical perspective and does not signal a material risk of future underperformance. The current borrowers’ financial health and credit stress is improving as realized losses declined from a peak of -0.91% in 3Q23 to -0.63% in 1Q25.

Read More from Stepstone Group