Private credit’s persistent premium
From the Field | 1Q 2025
Key insights
- Private credit historically offers a spread premium that persists through various base interest rate environments
- The private credit spread premium over liquid credit has ranged from 150 to 300 basis points (1.5-3%) over time
- This premium is composed principally of an “illiquidity premium” and “complexity premium”
- Private credit investors can capture the spread premium in exchange for committing capital longer term and providing lenders valuable execution and structural benefits
Private credit yields have three components—a floating base interest rate, coupon spread and original issue discount, as shown in the figure below. As a floating rate asset class, private credit yields move with the base interest rate, significantly reducing the volatility associated with longer term fixed income. In September, the Federal Reserve reduced its Fed Funds rate by 50 basis points to commence an expected monetary easing cycle after over two years of interest rate increases, the first such reduction in four years.(1) Given the potential for further declines in interest rates, OHA is frequently asked for its outlook on private credit returns in a falling interest rate environment.
Does private credit remain attractive in a falling interest rate environment?
OHA believes that the attractiveness of private credit in a given rate or market environment should be assessed relative to other comparable asset classes. Private credit pricing is most commonly compared to broadly syndicated loans (“BSLs”), also known as bank loans or liquid loans, which like a typical private credit loan is floating rate and senior secured in the capital structure. Recent data illustrates how private credit has maintained a return premium, in the form of incremental spread, over liquid loans, irrespective of base interest rates. In the figure below, private credit new issue spreads were 1.5% to 3.4% greater than BSL new issue spreads since 2019.(1) During this time period, base interest rates ranged from 0.0% to 5.3%.(3)
The private credit return premium is principally composed of two parts:
1) An “illiquidity premium” which compensates investors for locking up their capital for a longer period of time.
2) A “complexity premium” which results from the costs borrowers are willing to pay in connection with the many attributes private credit provides as discussed on the next page. These features are typically only available in the private market.
Taken together, the combination of these premia offer an attractive additional return to lenders while at the same time offering borrowers a compelling and feature rich financing alternative.
Why do borrowers choose the private markets?
OHA believes private credit is a more customized financing solution for borrowers compared to traditional syndicated loans. Private credit has accounted for approximately 85% of leveraged buy-outs (LBOs) since 2022.(5) Some of the reasons why private credit has become a preferred form of financing include:
Execution efficiency, simplicity and certainty: Private lenders can move with greater speed and can offer more certain pricing during time sensitive acquisition processes. Syndicated loan processes often have lengthy “road show” sales processes where banks market the loan to prospective buyers and may build in “flex” to increase pricing during the syndication process
Customization: Features and terms not typically available in the public market are made possible in private credit solutions. These include loans with delay draw features where private lenders can commit capital for future company growth
Consistent access to financing: Private markets have proven to be more reliable than traditional capital markets where traditional capital markets may close for business during periods of market turbulence, restricting a borrower’s ability to access capital
Confidentiality: During the often competitive bidding process for an acquisition, there is less risk of transaction details becoming publicly available given the smaller number of financing parties in a private credit transaction
Ratings independence: Private loans typically do not require a public rating from a rating agency and therefore may have greater ability to digest complex transactions. In contrast, syndicated loans are often ratings sensitive and may face difficulty in refinancing in the case of a ratings downgrade
Direct partnership with lenders: Borrowers are incentivized to build long-term, direct relationships with their smaller lender group, reducing the likelihood of activist investors entering the capital structure and lowering mark-to-market6 volatility of borrower valuations
Streamlined lender coordination: Private lending streamlines operational processes such as ongoing diligence demands and potential future amendments, refinancings, or upsizes to the existing capital structure
Conclusion
OHA believes the benefits of private credit justify a premium price compared to syndicated loans. At the same time, syndicated loans remain the financing source of choice for borrowers seeking lower cost of capital for less complex financing needs, such as refinancings. OHA believes this dynamic reinforces the long-term coexistence of private credit and syndicated loans.
Given the premium afforded by private credit and its durable attractive relative value proposition, OHA believes private credit will remain a compelling borrower and investor solution in a falling rate environment or if interest rate moves prove more volatile as monetary policy adjusts over time.
The 'Magnificent Seven' lender protections
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Credit market observations
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Appendix and endnotes
1) The federal funds rate is the target interest rate range set by the Federal Open Market Committee. It is the rate at which commercial banks borrow and lend their excess reserves to each other overnight.
2) Source: OHA analysis as of March 31, 2025. Illustrative unitranche pricing representative of market pricing. “Base Interest Rates” represents the three-month Secured Overnight Financing Rate (“SOFR”) as of March 31, 2025. Estimated spread and original issue discount has been prepared by OHA to reflect pricing of actual unitranche investments made as of the beginning of 2022 versus the current market. Original Issue Discount is the discount price from a bond’s face value at the time a bond or other debt instrument is first issued.
3) Source: Bloomberg as of March 31, 2025. Base interest rates represented by the Secured Overnight Finance Rate (SOFR).
4) Source: PitchBook LCD, Company data, Goldman Sachs Investment Research as of December 31, 2024. Private credit new issue spreads represented by business development company (BDC) new issue spreads. Includes: OBDC, ARCC, BXSL, MFIC, TSLX, GBDC, ASIF, BCRED, OCIC, OTIC, OBDC II, OTF, OTF II. Broadly syndicated loan new issue spreads represented by PitchBook LCD new issue data.
5) Source: PitchBook LCD as of December 31, 2024.
6) Mark-to-market refers to the process of valuing assets and liabilities at their current market price, rather than original cost or historical value.
Key risks and disclosures
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