November 5, 2025
Private Credit Markets – Q3 2025 Update
MACRO & FEDERAL RESERVE BACKDROP
Q3 2025 saw the macro narrative shift. Payroll growth slowed, unemployment edged up, and consumer spending lost momentum. In response, the Fed cut rates by 25 bps in September — perceived as the first move in a new easing cycle — citing rising downside risks to employment and persistent inflation above target. The Federal Open Markets Committee remains divided on the pace of future cuts, but the September action marked a clear shift toward supporting growth.
Markets responded with renewed optimism in rate-sensitive sectors, even as concerns lingered about the potential for inflation to reaccelerate.
PUBLIC MARKETS BACKDROP: RESILIENCE, ROTATION & RISK
The third quarter of 2025 was characterized by notable shifts across global financial markets, driven by evolving macroeconomic conditions and central bank policy. Equity markets delivered robust gains, commodities exhibited divergent performance, and credit markets remained resilient but cautious in light of the Federal Reserve’s recent rate cut and signs of labor market weakness.
Importantly, risk assets rallied. U.S. equities powered higher, with the S&P 500 and Nasdaq posting strong returns — led by large-cap technology and AI-driven sectors. The rally broadened to include cyclicals and small- caps. European equities posted modest gains, and emerging markets remained mixed due to currency volatility and uneven regional growth. Volatility was subdued for much of the quarter but increased as investors responded to shifting policy signals and macroeconomic headlines.
Commodities presented a varied landscape. Oil prices softened, with Brent drifting lower on surplus expectations and moderating demand, while gold and silver rallied to multi-year highs, supported by central bank buying and persistent geopolitical risk. Industrial metals, including copper and aluminum, remained under pressure from sluggish Chinese activity, and agricultural commodities experienced heightened volatility due to weather and supply disruptions.
Credit markets reflected the resilience seen in equities and commodities. Spreads tightened to multidecade lows — even as the market absorbed red flags from several high-profile bankruptcies in the consumer and specialty finance sectors. These events underscored persistent vulnerabilities in parts of the credit market, yet investor appetite for yield and risk remained robust.
Investment grade (IG) spreads hovered at just 5bps back off adjusted post-2000 lows. High yield (HY) spreads, while tight, remained about 90bps wide off composition-adjusted all-time tights, reflecting structural shifts toward secured bonds and shorter durations. Leveraged loans rallied, but we think they are unlikely to retest all-time tights, with post-GFC levels from 2018 within reach if technicals persist.
PRIVATE CREDIT: A RESILIENT HAVEN WITH LOWER MIDDLE MARKET STRENGTH
Private credit continued to stand out, offering a yield premium over public markets. Private credit deal flow was strongest in healthcare, technology, and specialized industries.1 Sponsors and borrowers turned to private credit for flexibility and reliability, particularly as we saw liquidity mismatches and slower exits drive the use of continuation funds and secondary solutions.
Direct lending in the lower middle market (LMM) remains especially attractive, characterized by its ability to command premium yields and robust structural protections. Unlike in broadly syndicated markets, where spreads tightened significantly,1 LMM lenders benefited from less competition and greater negotiating power. Spreads in LMM direct lending deals ranged from SOFR+450 to SOFR+475, reflecting a 100-150 bps premium over syndicated markets.1 This yield advantage is complemented by stronger covenants, including maintenance covenants and restrictions on additional debt, which provide lenders with enhanced control over borrower behavior.
Deal activity in the LMM focused on sectors with stable cash flows and growth potential, such as healthcare, technology (notably AI infrastructure and data centers), and specialized industries like sports media and events.1
LMM transactions, involving sponsor-backed companies with EBITDA between $10-50 million, allow private credit providers to negotiate bespoke terms directly with sponsors and management teams. These deals often offer not only higher yields but also equity kickers and success fees, enhancing risk-adjusted returns. The LMM’s ability to deliver tailored financing solutions —such as flexible amortization schedules or covenant packages tied to operational milestones — made it a preferred choice for borrowers unable to access syndicated markets.
The resilience of the LMM was underscored by its relative insulation from the competitive pressures impacting larger deals. As syndicated lenders have aggressively targeted large LBOs, capturing market share from private credit in deals exceeding $1 billion,1 LMM lenders have faced less encroachment. This dynamic has allowed LMM-focused funds to maintain pricing discipline and secure terms that mitigated risks, such as those exposed by recent consumer and specialty finance bankruptcies (e.g., First Brands and Tricolor Holdings). By prioritizing rigorous underwriting and ongoing monitoring, LMM lenders mitigate vulnerabilities like opaque financing structures and double-pledged assets, which plague weaker segments of the credit market.
BROADER PRIVATE CREDIT TRENDS: OPPORTUNITIES AMID CHALLENGES
While the LMM thrived, the broader private credit market wasn’t all peaches and cream in Q3 2025.
Deal volume declined, with estimated direct lending volume dropping from $75 billion in Q3 2024 to approximately $60 billion in Q3 2025.2 This decline was driven by a scarcity of large LBOs, compounded by an increase in loan repayments and exits.
Among the top 12 public business development companies (BDCs), new investment fundings fell by 11.6% in the first half of 2025 compared to 2024, while repayments rose by 13.7%, slowing portfolio growth to a trickle.2 The absence of robust M&A pipelines, disrupted by Q2 2025 tariff shocks and market volatility, further constrained deal flow.
Despite these challenges, private credit remains a vital source of capital for sponsors and borrowers seeking flexibility. High-profile transactions, such as ABC Technologies’ $2.3 billion private credit refinancing led by HPS and Apollo,3 highlighted the asset class’s ability to address complex liquidity needs.2 This deal, which refinanced hung bank debt from a failed syndicated loan attempt, underscored private credit’s role as a reliable alternative when syndicated markets falter.
Continuation funds and secondary solutions also gained traction, enabling sponsors to manage liquidity mismatches and extend holding periods for high-performing portfolio companies.2
Demand for private credit outstripped supply, creating borrower-friendly conditions that pressured spreads downward. The share of private credit loans priced below SOFR+500 increased in Q3, reflecting competition from an aggressive syndicated loan market.2
However, private credit’s structural advantages — such as customized terms and the ability to hold loans to maturity — allowed funds to maintain attractive risk-adjusted returns. For instance, private credit funds targeting healthcare and technology sectors benefit from fee structures and equity participation, which have the potential to boost returns beyond public market equivalents.
LESSONS FROM RECENT SECTOR BANKRUPTCIES
Recent bankruptcies in the consumer and specialty finance sectors exposed what we see as significant risks in credit markets, especially around fraud and collateral management. Opaque financing structures and double-pledged assets highlight the dangers of insufficient transparency and oversight.
Private credit and non-bank lenders were particularly affected, showing how operational failures and weak monitoring can lead to outsized losses.
The fallout has prompted lenders and investors to tighten standards, reassess risk controls, and pay closer attention to collateral arrangements. We believe that increased regulatory scrutiny and federal investigations signal a shift toward stricter compliance and higher costs for market participants.
What happened with First Brands and Tricolor Holdings serve as cautionary tales —reminding market participants that tight spreads and strong technicals can mask underlying risks, and that vigilance in transparency and risk management is essential as competition intensifies.
OUTLOOK & POSITIONING
For public securities, we see the risk/reward profile for adding credit risk as increasingly asymmetric. Spreads are hovering at or near historic lows, and the technical factors supporting tight spreads — low net supply, strong demand for yield, and sector rotation —are well understood. However, the margin for error is thin, and any reversal in technicals or macro sentiment could prompt a swift repricing.
In contrast, the private credit market continues to offer a substantial pick-up in yields. Direct lending and bespoke private transactions are benefiting from less competition, tighter covenants, and a more favorable supply/demand dynamic. Investors willing to navigate the complexity and illiquidity of private credit are being rewarded with spreads meaningfully above those available in public markets. The opportunity set in private credit remains robust, with sponsors and borrowers turning to non-bank lenders for flexible capital solutions.
BOTTOM LINE
While we’ve made this point in previous quarters, we continue to believe that the lower middle market of direct lending remains particularly attractive, for all the reasons outlined above.
Allocators should be thinking the following: Q3 2025 was a market defined by scarcity of spread and abundance of caution in public credit, but with compelling opportunities in private credit —especially in the lower middle market of direct lending. We believe that the focus should be on relative value within sectors and ratings, maintaining discipline on credit quality, and being prepared for volatility should the tide turn. For those able to access private credit, we think that the yield premium and structural protections make LMM direct lending a standout allocation in today’s environment.