In our second quarter loan market update, we focus on three themes shaping private credit.
First, in our previous updates, we discussed the direct lending market through the lens of four key factors: base rates, credit spreads, deal activity and credit stress. Those same factors remain relevant today, so we’re going to spend some time revisiting each of them and assessing how conditions have evolved.
Second, we’ll discuss how two lender-friendly tailwinds have emerged, specifically how base rates and credit spreads have moved in more favorable direction. As a result, the backdrop for direct lending returns is somewhat better than it was in the first quarter. That said, the benefits of these improvements are likely to be unevenly distributed across managers.
Third, in this unusually protracted credit cycle—now more than two years old—we believe certain portfolio vulnerabilities may lead to wider manager dispersion as some managers experience further erosion in performance.
In particular, we believe direct lending portfolios, with a higher proportion of junior capital, may be especially vulnerable in the period ahead. We’re watching this closely, as it may contribute to even higher levels of manager dispersion than we’ve noted in previous updates.
In the discussion that follows, we’ll revisit each of the four factors, assess where they stand today and share our view on what impact they may have on investors.
Expectations for Future Base Rates Have Increased
Let’s start with base rates.
Base rates have declined by about 175 basis points over the past two years. This had the negative effect of lowering the floating “base rate” component of direct lending returns.
At the start of 2026, consensus expectations were for base rates to decline by another 60 basis points. But recent strength in the economy and a spike in energy prices due to the conflict in the Middle East have reduced expectations for further rate declines. The July forward interest rate curve now indicates that the Fed may increase rates in the second half of 2026—a shift that currently amounts to a projected swing of approximately 85 basis points.
If that plays out, it could boost the base-rate portion of direct lending returns in the coming months.
Credit Spreads Are Modestly Wider Than at the Start of the Year
Next, let’s turn to credit spreads, which have also shifted in a slightly more positive direction for direct lending managers.
In Q1, spreads widened across both the broadly syndicated loan and the private credit markets. This generated meaningful unrealized mark-to-market losses in direct lending portfolios last quarter, driven by fair value accounting rules.
Private credit spreads are now modestly wider than where they began the year, which we expect will have a positive impact on prospective returns for newly originated loans.
This is the second headwind that has eased somewhat—and it could even turn into a more meaningful tailwind if deal flow improves.
Deal Activity Remains Muted
The picture is less encouraging when we look at deal activity, which remained muted during Q2.
U.S. private equity deal activity fell below $200 billion in Q2, compared with more than $250 billion in each of the prior three quarters.
Part of the decline came from a fall-off in new software-related deals, as fears of AI-driven disruption raised questions about the resilience of future SaaS revenue.
Credit Stress Remains Elevated
Finally, let’s look at our fourth headwind: credit stress.
We’ve talked for some time about the unusually protracted credit cycle we’ve been experiencing, really since the middle of 2023, when the gradual impact of rising interest rates began to pressure borrower cash flows and interest coverage.
Rising defaults did not really show up in manager loss rates until 2024. But persistent credit stress can wear on companies over time—like a swimmer treading water until, eventually, their legs tire.
While default rates have declined from peak levels, the cumulative impact of elevated credit stress continues to show up in rising portfolio loss rates, which have increased every year since 2023 and into 2026.
This has pressured direct lending returns at the broad asset-class level. Importantly, though, the impact of credit stress has not been evenly distributed across managers.
We see this uneven impact in performance data, which shows the gap in returns between top- and bottom-quartile managers widening substantially over the past few years.
One factor that may contribute to further dispersion is portfolio exposure to junior capital. In a prolonged period of elevated credit stress, investments lower in the capital structure may be more vulnerable. Managers with the highest junior capital exposure have recently exhibited both wider return dispersion and lower average returns than managers with the lowest exposure.
While these results do not predict future outcomes, they are a reminder that manager-specific portfolio construction is an important driver of returns and return dispersion.
Looking ahead, we believe managers with strong credit performance and resilient portfolios will be better positioned to benefit from improving market conditions, while weaker credit books are likely to remain under pressure.
Please note that the views expressed here reflect the current views of Golub Capital and are based on Golub Capital’s views of the current market environment, which are subject to change.
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Views expressed represent Golub Capital’s current internal viewpoints and are based on Golub Capital’s views of the current market environment, which is subject to change. Certain information contained in these materials discusses general market activity, industry or sector trends or other broad-based economic, market or political conditions and should not be construed as investment advice. There can be no assurance that any of the views or trends described herein will continue or will not reverse. Forecasts, estimates and certain information contained herein are based upon proprietary and other research and should not be interpreted as investment advice, as an offer or solicitation, nor as the purchase or sale of any financial instrument. Forecasts and estimates have certain inherent limitations, and unlike an actual performance record, do not reflect actual trading, liquidity constraints, fees, and/or other costs. In addition, references to future results should not be construed as an estimate or promise of results that a client portfolio may achieve. Past events and trends do not imply, predict or guarantee, and are not necessarily indicative of, future events or results. Private credit involves an investment in non-publicly traded securities which may be subject to illiquidity risk. Portfolios that invest in private credit may be leveraged and may engage in speculative investment practices that increase the risk of investment loss.
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Dispersion & Persistence of Manager Performance in Direct Lending
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