Morgan Stanley IM: Evolution of Direct Lending

Key takeaways include:

• Direct Lending is by far the single largest strategy within private credit today, having grown from 9% to 36% of total assets under management over the last 15 years.¹
• This growth has been fueled by borrower need and investor demand. Middle market companies have flocked to direct lenders as the number of banks has fallen by 53%,² and investors have seen Sharpe ratios enhanced by allocating more of their portfolios to Direct Lending.
• Direct Lending’s main target market, the middle market borrower, has demonstrated lower default rates and loss ratios when compared to the large corporate market for syndicated loans, based on 25 years of historic data.³

Direct Lending is a type of Private Credit strategy that makes direct, illiquid loans to middle market companies outside of the traditional banking system. Direct Lending usually refers to first lien loans as well as unitranche loans that combine different debt classes or liens into a single loan.

Learn more about the rise of direct lending from its small, early origins to its present role as a mainstay of the private credit industry.

¹ Source: PitchBook, March 31, 2024.
² Source: FDIC, as of December 31, 2023. Data from 2000 to 2023, measured by number of FDIC-insured banks.
³ Source: PitchBook LCD and S&P Credit Pro. Default rates based on the cumulative total of defaults between 1998 and 2023 on broadly syndicated institutional loans (12,223 issuers). Loss rate is calculated using the following formula: Loss Rate = Default Rate x (1 – Recovery Rate). Recovery rate data based on cumulative recovery on defaulted loans in the broadly syndicated institutional market between 1995 and 2023.

^DEFINITIONS:

^{Cliffwater Direct Lending Index (CDLI) seeks to measure the unlevered, gross of fee performance of U.S. middle-market corporate loans, as represented by the asset- weighted performance of the underlying assets of Business Development Companies (BDCs), including both exchange-traded and unlisted BDCs, subject to certain eligibility requirements.}

^{Earnings Before Interest, Taxes, Depreciation and Amortization (EBITDA) is essentially net income with interest, taxes, depreciation, and amortization added back to it, and can be used to analyze and compare profitability between companies and industries because it eliminates the effects of financing and accounting decisions.}

^{First Lien (also referred to as senior debt) is secured debt with first priority lien on borrower assets.}

^{Gross Domestic Product (GDP) is the monetary value of all the finished goods and services produced within a country's borders in a specific time period. It includes all private and public consumption, government outlays, investments and net exports.}

^{Leveraged Loan is a loan provided to issues who already have high levels of debt.}

^{Middle-Market Companies, in general, generate annual EBITDA in the range of approximately $15 million to $100 million.}

^{Sharpe ratio is a risk-adjusted measure calculated as the ratio of excess return to standard deviation. The Sharpe ratio determines reward per unit of risk. The higher the Sharpe ratio, the better the historical risk-adjusted performance.}

^{Unitranche is a hybrid loan structure that combines senior and subordinated debt.}

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^{Any charts and graphs provided are for illustrative purposes only. Any performance quoted represents past performance. Past performance does not guarantee future results. All investments involve risks, including the possible loss of principal.}

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