April 16, 2025 - Resilient portfolio performance and elevated base rates drove returns for U.S. direct lending loans higher into the fourth quarter and throughout last year, despite tighter spreads driven by increased competition. According to the Lincoln U.S. Senior Debt Index (LSDI), 4Q returns held steady at 2.8%, while the Cliffwater Direct Lending Index (CDLI) tallied a return of 11.3% for full-year 2024. For the fourth quarter, returns outpaced the 2.3% return for broadly syndicated loans (BSL), according to the Morningstar LSTA Leveraged Loan Index (LLI), and the 0.17% return from U.S. high-yield bonds, per the Bloomberg U.S. Corporate High-Yield Index – they were also ahead of the 9% annual return from BSL and 8.2% return from high-yield bonds. The CDLI is an asset-weighted index of over 17,000 directly originated investments held by business development corporations (BDCs) totaling $425 billion, while the LSDI represents the valuations of over 5,750 private companies across over 175 alternative investment funds conducted by Lincoln International’s Valuations & Opinions Group.
Direct lending loans returns have outperformed BSL every year expect one since 2005, per the CDLI. The strong performance is supported by stable portfolio valuations, with the average fair value across the LSDI and the CDLI in the 99 context across most of 2024. This was supported by robust earnings growth of 9.3% in 4Q, according to one measure of the 110-130 companies that are part of the Golub Capital Altman Index.
The asset class’s strong performance and growth attracted more competition, not just among direct lenders but also from a BSL market that was wide open for business, leading to tighter loan spreads. According to Cliffwater, average spreads for sponsored first-lien loans ended the year at 524 basis points, down from 591 basis points a year ago. Despite the spread compression, high base rates kept yields aloft. The LSDI ended the year with a yield of 10.7%, and the CDLI with a yield of 11% – both lower than a year earlier but elevated by historical standards.
As expected, yields for smaller companies were higher relative to large companies across both indices, with the credit picture for smaller borrowers more complicated. According to the LSDI, covenant defaults ticked up to 2.4% in 4Q, still low by historical standards, but marking the first increase in seven quarters. Smaller companies (defined as those with EBITDA less than $30 million) were more vulnerable and registered a covenant default rate of 13.8% in 4Q, compared to a sub-2% covenant default rate for other borrower cohorts.
For a more comprehensive picture of direct lending default rates, the KBRA DLD Direct Lending Index tracks defaults across distressed debt exchanges/restructurings, bankruptcies, missed payments and distressed exits for more than 2,500 borrowers. It reported a trailing twelve-month default rate of 1.7% in April (by count), with the caveat that the dataset does not include 1Q25 BDC filings that could produce several more restructurings. KBRA also flagged that the number of borrowers landing on its default radar, or at a higher risk of default, increased to 200 names in April 2025, from 183 at the end of 2024. Overall, the agency expects the default rate to inch higher this year to around 3%.
