Direct lending just had its worst quarter for deals in more than three years, and some of the largest private credit firms are now pursuing loans to companies with less than $20 million of earnings. That is happening while fundraising runs at a record pace.
Direct lenders had their worst quarter for new deals in more than three years in the third quarter, and some of the largest private credit firms are responding by going after much smaller borrowers, including companies with annual earnings below $20 million, Bloomberg News reported.
That is a shift for firms that built their businesses lending to large, sponsor-backed companies. The lower middle market has traditionally been served by smaller specialist lenders.
More money than deals
The drought in deals contrasts with the industry's fundraising. Direct lending funds raised a record $129.15 billion in the first nine months of 2026, according to Private Equity Wire. Private credit as a whole raised more in the first half of this year than in any comparable period in five years, according to the Alternative Credit Council, the industry's main trade group, which puts global private credit assets at $4.1 trillion at the end of 2025.
When capital raised grows faster than the supply of loans to make, the usual result is competition on price and terms. Lenders accept lower spreads, looser covenants or both to win deals. Moving downmarket is another way to find returns, by lending to borrowers that larger rivals previously ignored. How much spreads have actually tightened is not yet clear.
Credit quality
The move comes as credit quality draws attention. About one in six private credit funds report non-accrual rates above 5%, meaning loans on which they have stopped recording interest, according to the Alternative Credit Council's data. The group argues that public concern about the asset class has become divorced from the market-wide reality.
Smaller borrowers tend to be more vulnerable in a downturn, with less diversified revenue and thinner access to other financing. Lending more to them at tighter terms would raise the risk profile of portfolios even if headline default rates stay low for now.
A different view from the largest firm
Not everyone sees the environment as a problem. Blackstone, the largest alternative asset manager, sees widening credit spreads as a chance, Reuters reported this week. Its credit and insurance business took in $35.8 billion in the third quarter.
What to watch
Fourth-quarter deal volumes, spreads on lower-middle-market loans, non-accrual rates in business development company results over the coming weeks, and whether merger and buyout activity recovers enough to absorb the capital that has been raised.