Direct Lending
Direct Lending is private-market senior secured lending to companies through privately negotiated loans, typically with floating rates and covenant protections. Allocators evaluate it through underwriting discipline, documentation strength, loss controls, and recovery execution—not headline coupon.
Direct lending refers to non-bank loans originated by private credit managers—often to sponsor-backed middle-market companies—where returns are generated from contractual interest, fees, and disciplined loss management.
From an allocator perspective, direct lending is defined by downside controls: seniority, collateral, covenants, monitoring, and the manager’s ability to protect principal through deteriorating credit conditions.
How allocators define Direct Lending exposure
Allocators segment exposure by:
- Seniority: first lien vs second lien; security package quality
- Documentation: covenant-lite vs maintenance covenants; amendment behavior
- Borrower profile: sponsor-backed vs non-sponsored; industry cyclicality
- Origination channel: proprietary vs syndicated/auction; pricing discipline
- Portfolio construction: concentration, leverage profile, diversification reality
- Workout capability: intervention playbook and recovery history
The framing question is:
“How is principal protected when the borrower weakens?”
Core strategies within Direct Lending
- Senior secured (first lien): principal protection focus
- Stretch senior / hybrid: higher yield with structure complexity
- Lower middle market: more control, more idiosyncratic risk
- Upper middle market: scale and liquidity, more competition
How Direct Lending fits into allocator portfolios
Allocators use it for:
- Floating-rate contractual income
- Lower volatility vs equity risk (when documentation is strong)
- A defensive private-market sleeve with predictable cash flows
- Portfolio diversification from public credit (with different dynamics)
How allocators evaluate Direct Lending managers
Conviction increases when managers show:
- Repeatable underwriting standards and “no-deal” discipline
- Strong legal docs and real enforcement behavior
- Transparent loss history, recoveries, and watchlist governance
- Monitoring scale without dilution of oversight
- Cycle-tested portfolio construction (not concentrated carry trades)
What slows allocator decision-making
Common blockers:
- Covenant-lite risk without compensation
- Sponsor reliance without independent underwriting
- Weak transparency on amendments, breaches, and interventions
- Concentration risk hidden by “number of positions” marketing
- Overconfidence in benign refinance markets
Common misconceptions
- “Direct lending is safe because it’s senior” → only if docs and monitoring are real.
- “Higher spread means better” → spread can simply price higher loss severity.
- “Sponsor-backed equals protected” → sponsors protect equity, not always lenders.
Key allocator questions
- What explicitly disqualifies a deal?
- How often do covenants breach—and what happens next?
- What drives recoveries (collateral, control rights, sponsor support)?
- How does the book perform if refinancing shuts for 12–24 months?
- What’s the manager’s amendment philosophy in stress?
Key Takeaways
- Direct lending is a downside-control asset class, not a yield product
- Docs, monitoring, and enforcement define outcomes
- Cycle realism beats coupon marketing