We Are Going to Need a Bigger Borrower

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

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Direct lending or private lending, where companies borrow from private credit managers like OHA without a bank intermediary, offers investors A compelling opportunity to seek to earn premium returns with lower volatility than traditional asset classes.

As this opportunity continues to grow with larger companies increasingly accessing private financings, investors segment the market based on the size of the borrower into large cap and middle market.

Private lending investors often debate the relative value between larger and smaller borrowers, particularly as spreads and risk premiums have tightened across markets.

OHA believes larger borrowers present a more compelling investment opportunity due to their lower defaults and higher recovery rates, particularly given compression in private lending.

Spreads for smaller borrowers compared to larger borrowers.

Let's dive deeper into some of the math behind this.

Historically, in private credit, smaller borrowers have typically commanded higher spreads compared to larger borrowers.

This higher spread was intended to compensate investors for the higher risk associated with lending to a smaller borrower.

However, this pricing gap is compressed in recent years with smaller borrowers.

Command a spread than an average is roughly only 25 basis points higher than larger borrowers in the private markets.

Historically, larger borrowers have averaged lower defaults and higher recoveries than smaller borrowers.

Comparing larger borrowers to smaller borrowers since 2020, default rates of 1.7% are over 30% lower, while recovery rates of 54% are 30% higher, reflecting the generally stronger credit quality of larger borrowers.

Investors can further evaluate the relative value between larger and smaller borrowers by analyzing the impact of these defaults and recoveries on nominal private credit spreads, adjusting for losses based on historical default and recovery rates.

The recent spread for larger companies in private markets declines by 77 basis points.

The loss adjusted spread for smaller companies declines by 158 basis points, while the spread for smaller companies offers that 25 basis point premium.

On a loss adjusted basis, larger borrowers actually offer a premium of 56 basis points.

In a stress test scenario such as the 2020 COVID dislocation, default rates increase and recovery rates decrease among both larger and smaller borrowers.

However, the loss adjusted spread premium for larger borrowers increases to over 300 basis points since larger borrowers were able to better navigate this downturn.

Based on these same default and recovery assumptions, the spread generally offered by smaller borrowers would have to be 81 basis points higher than larger borrowers for the 2 to generate the same loss adjusted spread.

For over 30 years, lending to larger companies has been OH as focus.

We believe managing downside risk is a key source of alpha generation for credit investors and believe that larger companies when compared to smaller companies may provide a more compelling opportunity for investors today, particularly now in the current dynamic market environment.

Investors should consider company size when evaluating an investment in private credit.

I'm Alan Trigger.

I'm a senior partner at OHA.

“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.

Fig. 1: Private Lending Spreads by EBITDA Size^1,2

As of June 30, 2025

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.

Fig. 2: Illustrative Loss-Adjusted Spread³

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.

Alan Schrager

Portfolio Manager & Senior Partner

Jun 2025 From the Field

Credit Market Observations — Mid-year 2025

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

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Opinions and estimates offered herein constitute the judgment of OHA as of the date this document is provided to you (unless otherwise noted) and are subject to change, as are statements about market trends. All opinions and estimates are based on assumptions, all of which are difficult to predict and many of which are beyond the control of OHA in addition, any calculations used to generate the estimates were not prepared with a view towards public disclosure or compliance with any published guidelines. In preparing this document, OHA has relied upon and assumed, without independent verification, the accuracy and completeness of all information. OHA believes that the information provided herein is reliable; however, it does not warrant its accuracy or completeness.

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Important Information

This material is provided for informational purposes only and is not intended to be investment advice or a recommendation to take any particular investment action.
The views contained herein are those of the authors as of September 2025 and are subject to change without notice; these views may differ from those of other T. Rowe Price associates.
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