In the equity guide, this chapter covered the J-curve, vintage effects, and manager dispersion. Credit works differently. A loan pays from the first quarter, so there is no early trough to explain to a client. The loan document takes its place, where the real risk decisions are made.
Floating rate mechanics
Nearly all direct lending is floating-rate, priced at a benchmark plus a spread.
This is why private credit carries almost no interest-rate duration and why its income is not fixed. When short-term rates fall, income falls with them, cushioned only to the extent that floors are in place and still binding.
The other components of yield
Spread is the largest piece of return but not the only one.
- Original issue discount (OID). The loan is funded at a slight discount to face value, for example, at 98 cents on the dollar for a $100 obligation. The lender collects the full $100 at maturity, and the difference accretes as additional yield. PitchBook LCD reports typical recent OID levels of roughly 2 to 2.5 points on unitranche loans, down from about 3 points earlier in the cycle.9
- Call protection. Fees the borrower pays to repay early, which compensate the lender for the loss of a performing loan.
- Amendment and prepayment fees. Paid when terms are renegotiated or the loan is retired early.
The diagram captures the chapter's central point. Headline yield is gross. What reaches the investor is net of credit losses, fund expenses, and the cost of any borrowing the fund undertakes, and fund-level leverage magnifies the result in both directions.
Covenants and why they matter even when never enforced
A maintenance covenant is best understood as an early-warning system rather than a weapon. When a borrower triggers it, the lender gets a seat at the table while the company still has options, which is when restructuring outcomes are best. A covenant-lite lender often learns about trouble later, when options are more limited.
The trend has shifted against lenders at the large end of the market. McKinsey reports that covenant-lite structures rose to 21% of direct lending deals in 2025, up from 4% in 2023.10 As Chapter 2 noted, that erosion is concentrated in larger deals rather than spread evenly across the market.
The protective ratios
Four numbers indicate whether a loan is safe, and advisors should know what each one protects against.
- Leverage multiple (debt ÷ EBITDA). How many years of earnings the borrower owes. Guards against over-borrowing.
- Loan-to-value (debt ÷ enterprise value). How much equity cushion sits beneath the loan. Protects against the company being worth less than its debt.
- Interest coverage (EBITDA ÷ interest expense). Indicates whether the borrower can actually pay. Guards against liquidity failure.
- Fixed-charge coverage. The same test, expanded to include other mandatory payments.
Interest coverage deserves particular attention in a floating-rate asset class because it changes when rates change, even if the business does not change at all.
Spreads, and what happens when they compress
Competition has compressed spreads, and the past three years have seen significant compression. PitchBook LCD reports that the average spread on US leveraged buyouts financed in the direct lending market contracted to 555 basis points, down 115 basis points from 2023 and 161 basis points from 2022. The median spread on private-equity-backed acquisition deals settled at SOFR plus 475 basis points, with the largest share of tracked deals (48%) pricing between SOFR plus 450 and 499.9
Two forces then act on investor income at once: tighter spreads and lower base rates. Both reduce yield without any credit deterioration. Advisors setting client expectations should clearly separate the two, because a decline in income is not the same as a decline in credit quality, and neither is the same as a loss.