Last week in our special series on visibility in direct lending, we touched on the element of risk/reward. This week we examine relative credit losses and liquidity of the asset class.

The issue of private credit losses cuts to the heart of transparency. Since middle market borrowers are generally smaller, private, and unrated, and their financings illiquid, it’s a challenge getting accurate default and recovery data.

In Private Debt: Opportunities in Corporate Direct Lending, Steve Nesbitt uses the Cliffwater Direct Lending Index to help shed light on this question. Data from the CDLI derives from 6000 loans accumulated in the 2005-2017 timeframe. It shows middle market loans with an 11.15% yield and just over a 1.03% cumulative average loss rate.

In comparison, leveraged loans had losses of 0.94% and high-yield bonds were at 1.40%. As Nesbitt points out, given the roughly 4% additional yield offered by direct loans, the risk/reward trade compensates investors for illiquidity and losses.