We Are Going to Need a Bigger Borrower
Fall 2025
Summary
- Investors often debate the relative value between lending to “large cap” and smaller companies as the private lending asset class has matured
- Smaller borrowers generally offer higher spreads commensurate with risk, but this spread premium compared to larger borrowers has compressed, as spreads across markets have tightened
- After adjusting for the lower defaults and higher recoveries shown historically by larger borrowers, OHA believes larger borrowers offer investors a full-life spread premium over smaller borrowers
Alan Schrager
Portfolio Manager & Senior Partner
“Large Cap” vs. Smaller Borrowers
Smaller borrower spread premium has compressed
Private credit has expanded to finance a larger universe of borrowers. Originally limited to smaller, or middle market, borrowers unable to access the broadly syndicated loan (“BSL”) market, private credit has reached scale required to finance larger companies. These large cap borrowers also increasingly seek private solutions driven by potential benefits such as greater customization, speed and ease of execution and increased confidentiality. As these asset classes mature, investors increasingly evaluate the relative value between large cap and middle market private lending.
Historically, smaller borrowers have offered higher spreads, or a spread premium, versus larger borrowers to compensate investors for higher credit risk and complexity. However, recent data shows that, as spreads have tightened, this spread premium has compressed to only 25 basis points (0.25%) on average compared to 50-100 basis points historically. OHA believes this compression reinforces the investment case for large cap private lending, particularly when considering differences in historical credit losses from defaults.
The Larger Borrower Spread Premium
Adjusting private credit spreads to evaluate loss-adjusted spreads
Losses from defaults can be a significant driver of ultimate returns and the premium actually earned from lending to larger versus smaller companies. OHA believes loss avoidance is a substantial source of differentiation across private credit managers, particularly during periods of market dislocation.
Larger borrowers are positioned to deliver higher spreads than smaller borrowers when adjusting for potential losses from defaults. Figure 2 below shows the impact of the differences of new issue spreads, defaults, recoveries and losses between larger and smaller borrowers. Since 2020, larger borrowers have shown default rates approximately ~38% lower and recovery rates ~30% higher than smaller borrowers. Under these long-term average default scenarios, average annual losses from defaults for larger borrowers of 0.77% are roughly half the 1.58% implied for smaller borrowers. When these defaults losses are applied to the new issue spreads assumed in today’s market of 5.00% for larger borrowers and 5.25% for smaller borrowers, implied larger borrower spreads are 0.56% (56 basis points) higher than smaller borrower spreads. OHA believes this difference represents a “larger borrower premium” that captures the higher credit quality of larger borrowers and offers attractive relative value.
OHA believes larger borrowers possess several features that may better position them to service their debt obligations through various market environments including greater scale, pricing power, more experienced management and diversified revenue streams. Find out more about OHA’s historical preference for larger borrowers and their attractive characteristics in OHA’s white paper on “Why Company Size Matters in Direct Lending”.
The “larger borrower spread premium“ is amplified when evaluating past market dislocations. Figure 2 also shows a stress test scenario which captures the 2020 COVID dislocation to illustrate the potential impact of higher default and lower recovery rates experienced in a market dislocation. Using the same methodology above, default losses would more than fully erode the current new issue spread for smaller borrowers while larger borrowers still generate a full-life positive spread. The implied loss-adjusted spread premium for larger borrowers is 3.15% (315 basis points) compared to smaller borrowers.
Lastly, we evaluate the breakeven spread between larger and smaller borrowers to understand how much higher the spread for smaller borrowers should be to compensate for greater default losses. This analysis implies that the new issue spread for smaller borrowers should be over 80 basis points (compared to 25 basis points currently) higher than larger borrowers currently to offer than same full-life spread in a long-term defaults case, and 340 basis points higher in an illustrative stress case.
OHA believes effective downside protection is a key source of alpha generation for credit investors. OHA has maintained its emphasis on loss avoidance with its consistent focus on larger borrowers for over 30 years. Historical data below suggests larger borrowers may deliver differentiated performance compared to smaller borrowers when adjusting for credit losses.
Takeaways
- Based on historical default and recovery rates, OHA believes smaller borrower spreads would need to be 0.81% (81 basis points) higher than larger borrowers to generate the same loss-adjusted spread
- With smaller borrowers only offering a 0.25% (25 basis points) premium to larger borrowers, OHA believes larger borrowers offer a more compelling investment opportunity on a loss-adjusted basis
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Appendix and Endnotes
1. EBITDA is defined as earnings before interest, tax, depreciation, and amortization. EBITDA is often used as a proxy for cash flow.
2. Source: Lincoln International, OHA market observations as of June 30, 2025. Larger borrowers represented by borrowers with greater than $100 MM in annual EBITDA. Smaller borrowers represented by borrowers with less than $40 MM in annual EBITDA.
3. OHA analysis as of June 30, 2025. Larger borrowers represented by borrowers with greater than $100 MM in annual EBITDA. Smaller borrowers represented by borrowers with less than $40 MM in annual EBITDA. Stress test represented by the peak default and lowest recovery rates from January 1, 2020, to December 31, 2020. New issue spreads sourced from Lincoln International and OHA market observations. Default rates represented by the Proskauer Private Credit Default Index. Long-term defaults represent the average default rate since 1Q 2020. Stress test defaults represented by the highest default rate since 1Q 2020. Recovery rates represented by the Cliffwater Direct Lending Index. Long-term recovery rates represented by the average recovery rate since 1Q 2021. Stress test recovery rates represented by the lowest recovery rate since 1Q 2021. The CDLI-Upper Middle Market (“CDLI-UMM”) and CDLI-Lower Middle Market (“CDLI-LMM”). CDLI-UMM is comprised primarily of loans held in BDCs who focus on lending to borrowers in the upper middle market, which Cliffwater generally defines as borrowers averaging $100 million in annual EBITDA and greater. CDLI-LMM is comprised primarily of loans held in BDCs who focus on lending to borrowers in the lower middle market, which Cliffwater generally defines as borrowers averaging less than $40 million in annual EBITDA.
Key risks and disclosures
The Proskauer Private Credit Default Index (PCDI) is a quarterly index published by the Proskauer law firm that tracks the default rate of U.S. dollar-denominated senior secured and unitranche private credit loans, including payment defaults, bankruptcies, financial covenant breaches, and material amendments made in anticipation of default.
The Cliffwater Direct Lending Index is a widely accepted benchmark that measures the unlevered, gross-of-fees performance of U.S. middle-market corporate loans, using the underlying assets of Business Development Companies (BDCs) as a proxy for direct lending.
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