Private Credit Terms Evolving: Spread Compression and Covenant Deterioration as Competition Intensifies

As competition intensifies in private credit, deal terms are becoming increasingly borrower-friendly — a dynamic that mirrors earlier phases in the broadly syndicated loan market and raises questions about future recoveries.

Spread Compression

• Average spreads on US LBOs financed by direct lending contracted 161 basis points between 2022 and 2024, falling to levels that left lenders with diminishing cushion against deterioration.
• Recent transactions indicate that syndicated loans are now priced roughly 200 basis points lower than private credit alternatives, creating a meaningful incentive for higher-quality borrowers to migrate back to the BSL market.
• As the BSL market re-opens, private credit lenders are forced to tighten spreads and offer more covenant-lite terms to remain competitive.
• Apollo CEO Marc Rowan noted in the Q1 2026 earnings call that "most of the funds investors have invested in levered lending have come from the sale of their equity portfolio," and that "the notion that a loan is somehow riskier because it wasn't originated by a bank is not a coherent argument. Private credit is just credit."

Covenant Deterioration

• Covenant-lite terms that originated in the broadly syndicated loan market have migrated into private credit documentation.
• In software lending specifically, ARR-based underwriting has largely replaced traditional EBITDA covenants, removing the earnings test that would serve as an early warning mechanism.
• Competitive pressure during the 2021-2024 inflow cycle led to systematic softening of covenant protections, which is now being stress-tested as AI disruption hits SaaS borrowers.

Banks Re-entering the Fray

• Banks' exposure to private credit reached approximately $1.4 trillion at end-2025 (Moody's). Credit lines extended by the largest US banks to private credit vehicles increased ~145% between 2020 and 2024 to ~$95 billion.
• Wall Street banks are now using credit default swaps to take on private credit fund exposure from Blackstone, Apollo, and Ares, deepening the interconnection between regulated and shadow banking.

The "Crowding" Concern

• More capital flowing into private credit can compress spreads, especially for higher-quality borrowers — a growing concern among allocators worried that private credit's popularity could reduce future returns.
• Scale is becoming increasingly important: managers with privileged bank partnerships (e.g., Citi-Apollo, Citi-BlackRock/HPS) have sourcing advantages that may allow them to preserve economics on complex, non-auctioned deals while smaller lenders face spread compression on more commoditized transactions.