June 12, 2025 - The U.S. direct lending market posted softening sequential results in the first quarter of 2025, highlighting the asset class’s resilience but not fully capturing the uncertainty that roiled markets in early April, according to two leading market benchmarks. Total return in the first quarter softened to 2.1%, according to the Cliffwater Direct Lending Index (CDLI), which tracks $465 billion of directly originated middle market loans held by BDCs (business development corporations). The Lincoln Senior Debt Index (LSDI) returned 2.2%, a decline of 0.6% from the prior quarter. The LSDI is derived from the universe of 6,000 private companies that Lincoln International evaluates on a quarterly basis. Both indices outperformed the broadly syndicated loan (BSL) market, which returned 0.48%, according to the Morningstar LSTA Leveraged Loan Index (LLI).
First quarter data predates the market volatility and uncertainty from the April 2nd tariff announcement, with the average fair value (FV) on the LSDI only seven basis points lower to 98.7, and the average FV for the CDLI remaining stable in the 99.5 context. By contrast, the BSL market registered a steeper drop of 102 basis points.
While direct lending loans continue to benefit from the higher-for-longer interest rate environment, CDLI interest income remained elevated at 2.5%. However, this marked a decline from 2.7% in 4Q24, and 2.9% a year earlier. The drop in interest income was driven by base rate, fee and spread compression, as increased competition among lenders pushed yields on first-lien loans down to 9.8% – the lowest since 3Q22, according to analysis from Cliffwater. Meanwhile, in the LSDI, interest income made up 1.6% of the index’s 2.2% total return.
Despite the pressure of elevated interest rates, realized losses in the CDLI stand at 0.18% in the quarter, which is up over the prior quarter but below the long-term average of 1%. From another angle, the share of non-accrual loans in the CDLI remained stable at 1.3% and below the long-term average.
From the standpoint of defaults, the LSDI tracks covenant breaches, which rose 0.5% to 2.9% in 1Q – the second consecutive quarter this metric increased after troughing at 2.2% in 3Q24. Smaller companies are more likely to default. Borrowers with EBITDA less than $30 million had a 10.5% default rate, compared to 4.3% for borrowers with EBITDA between $30 million and $100 million, and 0.7% for borrowers with EBITDA over $100 million.
From another vantage point, the KBRA DLD Direct Lending Index tracks defaults across restructurings, bankruptcies, missed payments and distressed exits for more than 2,500 companies in the U.S. direct lending market, representing nearly $200 billion. The index showed a trailing 12-month default rate of 2% (by volume) on June 10th, up from the 1.8% rate reported at the end of 2024. However, KBRA is forecasting the default rate to decline to 1.5% by year-end, with default activity for smaller borrowers in the lower middle market (which KBRA derives from the universe of 13 BDCs that focus on this space) projected to increase to 3%, from 1.9% currently.
