Growth in Direct Lending

September 22, 2016

This week’s chart shows the significant growth in direct lending over the last decade, as indicated by the number of funds and amount of capital raised.

Direct lending is defined as a loan made by a private entity to a small–medium size company which generally carries a floating interest rate. The loans have a 3- to 5-year term and are in most cases held to maturity. For some perspective, this space was largely dominated by commercial banks and proprietary trading desks at investment banks leading up to the global financial crisis of 2008 when private lenders had little market share. The landscape has changed since then as banks now face significant regulatory pressure as a result of the Basel III and Dodd-Frank bills, which call for higher risk-based capital charges for non-rated loans and an increase of 25% or more in Tier 1 capital ratios by 2018, making the practice of direct lending an increasingly inefficient use of bank balance sheet capital.

As a result, banks today are virtually inactive in this area and direct lending by private investment managers has emerged as a natural structural replacement. On the demand side, the current low global interest rate environment is fueling increased appetite for this strategy as investors continue to search for yield and diversification in their portfolios.