CJ Doherty:
Welcome to the Lending Lowdown. I'm CJ Doherty, director of market analysis at LSEG LPC. As we are now approaching the end of 2025, I thought it would be a good time to take stock of the past year and look ahead to 2026 in the private credit space, given the asset class continues to attract large amounts of capital, thus growing at a rapid clip and garnering a lot of attention. And in order to do that, my guest today is Garrett Stephen, who is a senior managing director and co-head of origination at Napier Park Global Capital. Garrett, it's a pleasure to have you join me today.
Garrett Stephen:
Thanks, CJ. Appreciate you having me.
CJ Doherty:
Great. So, first, can you give our listeners some background on yourself and your firm? Before we delve into the market?
Garrett Stephen:
Yeah, I'd love to. I started my career in restructuring prior to joining the firm 13 years ago. I've been involved in all facets of the business, which include portfolio management, underwriting, workouts, origination and capital raising activities.
As you mentioned, I serve as the co-head of origination at Napier Park. I'm a member of the Direct Lending Investment Committee, also, a portfolio manager. Our direct lending business traces its roots back to THL credit nearly two decades ago. Which became a part of First Eagle in 2020. We've maintained the same core underwriting team and approach throughout that evolution in that time period.
Today, our direct lending team sits within First Eagles Global alternative credit platform, Napier Park. Alongside our opportunistic credit strategies, specialty finance capabilities, CLO platforms. Together, the platform manages about $40 billion in credit assets under the broader First Eagle Investments, $170 billion plus umbrella.
CJ Doherty:
Great. So, let's start very broadly and look back at the past year. What have been the key market themes in the direct lending private credit space in 2025? From your vantage point?
Garrett Stephen:
Yeah, that's a great question. I describe it as choppy beginnings followed by cautious normalization. I think we've been dealing with a lot of uncertainty over the past several years.
2022 was really a period where we saw rising interest rates, we saw geopolitical war. 2023 and 2024, those interest rates continue to rise. But those interest rates started to abate in the back half of 2024, when we started to see more optimism from the dealmaking community to come back and really push maybe some of their portfolio companies out into the market that they may have been holding on to.
So, I think there was a lot of optimism coming into the year. I do think there was a choppy start, largely due to the fact that we were dealing with Liberation Day. A lot of folks coming into the year were expecting the Trump administration to allow a relaxed attitude going into the market, and I think there was a lot of optimism around that.
However, as we experienced in April and May, there was a pullback because no one knew what the new normal would be. We were all trying to figure out where the market was going to be so that, that basically caused more muted issuance volume from our perspective. We did see a resurgence in folks once everyone assessed their portfolio companies what the broad impacts might be.
Was it a services focused portfolio company? Was it a little bit more tariff laden or tariff ridden with some industrial companies and what that might look like? And once folks got past that, I'd say, understanding of what was really going on in that particular portfolio company or that borrower, then it returned to the perspective of, do I want to launch this business or not?
Furthermore, I think it was really driven by the fact that what was the capital markets going to do? As we all know, the capital markets as us lenders and the private credit space really need to understand what is the normal, what are we underwriting into? And it took a little bit of time just to step back and reflect and make sure that there wasn't going to be some broad impact, whether that was direct or indirect, to that portfolio company, that may cause an issue down the road.
And once the market reacted and was able to look at portfolio company by portfolio company and underwrite those business specific issues, as we all do, I think there was, you know, a resurgence or a return to getting back, getting deals done and wanting to put money to work. With that being said, that did open up the competitive forces and dynamics in the market that we've seen over the course of the last quarter or two, whereby interest rates started to come down, spreads have normalized into the ranges that we see today.
And just more broadly, with respect to whether or not those portfolio companies of those private equity firms deciding whether or not they want to launch their business. So overall, I'd say we feel good about where the market's going. We feel like there is a lot more activity that we're seeing broadly in the market, but it did take a little bit of time post Liberation Day for us to see that.
And I think it's been almost a tale of two cities where there's been some really good companies out there in the market that are more A-grade, and then there's a subset of portfolio companies that may be going through some level of stress or distress and trying to use the robust capital markets to figure out a second way out.
CJ Doherty:
Let’s dig in a little bit. What sectors do you focus on in your lending portfolio and what is your outlook for them? You know, where are you seeing the most opportunities and challenges within those sectors?
Garrett Stephen:
Yeah, we've always been a sector specialist. So, what we did years ago was we set up several verticals that we like to be very deep within those four core verticals are healthcare, technology, business services and financial services.
And it became extremely important from our point of view to really focus on particular sectors, because it's hard to be a generalist in the market today. If you look at the private equity market community, if you look at just the market more broadly, you need to really come to the table with a perspective. And having that sector specialization enables us to have that subsector theses and thoughts that we can bring to the table and say, is this a space that we want to transact in or not?
So, if you really drill down into those subsectors is really how we think about the world is we've seen activity within healthcare move away from a lot of activity between 2019 and 2021, and physician practice management, that's moved a little bit more towards revenue cycle management, pharma services, payer services, health and wellness as a recent. Within technology, we've seen a lot of on the services side, a lot of folks focus on managed service providers.
There's been as of late, a lot of focus on cybersecurity as well as the cybersecurity MSP businesses. Data centers, obviously, is a big one that folks are focused on, and software has continued to remain attractive that we like. We continue to look at. It's really a function of what is it? What type of loan is it? Is it more of an annual recurring revenue loan, or is it a cash flow-based loan that you can actually value the amount of cash flow that the business is operating in the software business? Business services, I'd say over the course of the last 18 months, HVAC, plumbing and the like have been very attractive, have been seeing a lot of market activity. But we've seen that shift a little bit more towards engineering and architecture. We've seen several deals in the space there.
Fire, life and safety has been another area where we've seen robust activity as well as landscaping. And finally, on the financial services side, I'd say wealth RIAs have seen a lot of activity. Brokers have been continue to remain attractive just given the business model. So overall, we remain relatively comfortable with the sectors that we're seeing. I'd say broadly, if I had to give a theme to it is industry fragmentation or strong organic growers are really attracted to private equity firms. Those are the type of businesses where you can create value, whether that's through multiple arbitrage opportunities on the add on side or really taking a strong business and helping that founder or entrepreneur turbocharge that growth by putting in better board governance and helping them have the capital to continue to support their business for maybe something on the CapEx side that they didn't have the capital to do themselves.
CJ Doherty:
And as we all know, AI is hitting the headlines these days and its impact is reverberating throughout the markets and the broader economy. So, my question for you is how is the potential disruption by AI impacting your underwriting process and how you review your existing portfolio?
Garrett Stephen:
I’d expect it to vary by company size. It's still a very fluid topic. It's one that we're on top of every day. I'd say on the AI side, it's really a big focus at the business level for us on making sure that we're implementing AI more broadly within our work streams to stay ahead of the curve. But if I think more broadly, as we all evaluate businesses on our end and as we think about it, our core underwriting standards haven't changed.
And that's important. You need to be able to invest across market cycles. And one of the most important attributes as we look at AI is, I like to frame it as looking at a bell curve, right? is if you think about a bell curve, you have a company that may be a startup, and then they may follow that bell curve and they may be growing and then it may reach maturity, and then it may kind of come down the other side of that curve and become more of a declining business.
And as we think through AI, I think those each one of those business models that's following that curve is going to be impacted differently. If you have a large workforce and maybe not every individual within that workforce is productive, and you can utilize technology to make your core employees more productive, that potentially could cause some of that workforce to decline in those mature or declining businesses, because you're able to take that technology backbone and overlay it across your business.
But if you look at a lot of those growing businesses on the beginning parts of that maturity curve, the beginning part of that maturity curve, you may be a bootstrap business or you may be a small business that is still investing in their infrastructure, and you might want to invest heavily, or they are already investing heavily in AI and utilizing that to drive productivity.
So maybe their business plan calls for, they started with 50 employees today, and they're going to grow to be 300 employees. And that perspective is important because they're going to utilize AI, they're going to figure out ways to be productive. But given the total addressable market that they have, they may continue to invest in the overall workforce that they have.
However, if you weren't a mature or declining business and there might be something that is attacking you just from your total addressable market, maybe it's a barrier, you know, maybe your barriers to entry aren't as strong or something else is impacting that business model. Can you innovate enough or can you spend that capital expenditure to stay ahead of the curve so you're not declining at the same rate, or you're staying at that stable revenue level that you want to stay at?
So, I think more broadly, it hasn't impacted our underwriting process or portfolio. Broadly, I'd say it's a key consideration, just as we have invested through market cycles and adopting. How do we look at this more broadly? When we underwrite businesses, we're always looking at if it's for a cash flow loan, it's where 100% sponsor back. So, who's the private equity firm? Who's the management team? What are the industry fundamentals? What is the structure? And we really need to take that into account when we're looking more broadly at what is the whole package look like. And when we look at the structure and the free cash flow and the fixed charge coverage dynamics of that particular business, a key consideration of the free cash flow that you're generating is the CapEx that you're spending.
And as we see now is, if you're investing in many businesses or services businesses, if you're investing in CapEx to automate the technology stack internally and utilize that to increase productivity, there may be in an outlay of capital expenditure to make that more productive. So, what we're trying to better understand is what is the ROI on that CapEx and what, you know, ultimately, as that company is spending those dollars on and to generate this ROI is how long is it going to take? And what are the other market forces that are potentially impacting us in that particular business that could potentially cause this business to have an issue between when it is, you know, starting that implementation between when it ends and then really the work after you implement it is how are you staying ahead of the curve?
How are you constantly innovating? So I think it's a key consideration that we have. And there's no right or wrong answer right now. It's what we're trying to do is make sure that it's a key consideration and understand what are the market forces more broadly in that particular portfolio company, and how can that company utilize AI to either grow faster or create more, more productivity and more broadly in their business?
CJ Doherty:
The hope for more M&A has been a consistent theme in recent years, and there's been some recent positive signs around dealmaking, I think. So firstly, what is driving this relative improvement? And secondly, what do you see ahead for M&A activity in 2026?
Garrett Stephen:
First, I’d start more broadly with, I think from a volume perspective, it varies from company size more broadly with respect to is this upper market? is this core middle market? is this lower market?
So, one of the broad trends that we've seen has been in the lower middle market. It's really a function of these first time owners or entrepreneurs who are looking to sell for the first time to either a private equity firm or the like, in order to help them stand up the governance internally, to help them have additional capital to grow and support their business, to get that advice more broadly within their portfolio company, to be able to grow that business appropriately and scale it, which they may not be experienced, that they have.
So, I'd say in the lower middle market, we've seen and I define that maybe somewhere between $5 million and $30 million of EBITDA, whereby there's been maybe less of an impact more broadly because it's that entrepreneur that's deciding, do I want to sell? And that sell reason could be for wealth transfer, it could be for estate planning, or it could be I see this a total addressable market opportunity. I need more capital to take advantage of it. And I want to bring in a private equity firm to help me out on that front. I'd say secondarily, as you look at that core middle market, and that could range anywhere between $20 million and $100 million of EBITDA or as we define our core middle market, lower middle market, somewhere between $5 (million) and $50 (million) is there's a large degree of private equity firms selling to private equity firms.
There's also that deal flow between private equity firms selling to strategics. And as we've looked at it, it's really been a function of those private equity firms being a little bit more calculated and whether or not I want to sell, and that has muted the overall transaction volume. And then there's the upper market that has remained active.
So, the overall trend that we've seen more broadly in the market has been a lot of refinancings going on in the public markets or large cap private credit markets. There's been an increased level of dividend recap activity because a lot of folks have been waiting to sell their businesses and have using dividend recap activity to realize some level of return of capital.
Within the core middle market. We've seen just sponsors more broadly testing the market, but potentially not selling the business because they feel like they're leaving some level of return on the table. We've also seen a level of activity whereby private equity firms will sell a partial stake and allow a new private equity firm to take majority control, but they'll roll a significant amount of their proceeds because they still believe in the industry fundamentals, they still believe in the management team, and it's an opportunity for those folks to stay in a good performing credit with a borrower that they know and continue to realize additional return. And the lastly, as I mentioned in the beginning, is it's really those entrepreneurs making that particular decision on their own. So, I'd say more broadly, you look at data and the data is really different, source to source. It's really hard to get really good concrete data in the private credit market because you need to follow so many different sources.
From our perspective, it feels like deal count has been down, transaction volume from a dollar perspective has been up. But that dollar volume has been skewed by some really large transactions. So, if you were to take that out of the narrative or that out of the picture and really look more broadly at what does the transaction count look like, and are we really getting some acceleration and deal flow?
It feels like we're approaching that and there's optimism going into 2026. But for 2025, I'd say that overall volume, because of the choppiness start to the year and because a lot of those A-grade assets were the ones launching, we haven't seen that deluge of deals come out to the market just yet because those be assets or key assets. We're still waiting to feel that new normal.
And it does feel like as we head into next year, there's more optimism around that.
CJ Doherty:
And the final topic I want to touch on briefly is credit quality. You know, as credit quality metrics are closely watched when it comes to private credit for any warning signs. And from what I've seen, these metrics haven't shown any marked deterioration across the board. Rather, it's been more of a case of idiosyncratic risk. What are you seeing when it comes to credit quality, and what do you expect to see going forward?
Garrett Stephen:
I’d agree generally with that comment. As I mentioned in the prior commentary more broadly about transaction volumes in the market, one of the difficult things is just where are you getting your information and what is your transaction source?
And sometimes not all of this information is public. As you look at a lot of sources, there are obviously a difference between public funds and private funds, and sometimes not all of that information is available. I think as we've looked at more broadly, it does feel like just from a default rate perspective on a headline, it remains relatively low.
It remains it remains stable, which gives us all comfort. There's a lot of focus right now around pick payment and kind. With respect to how is that involved in the overall construction of the portfolio and I'd say more broadly, as you look at that, the PIK utilized could be on the front end, which we don't utilize, or it could be utilized on the back end with respect to helping a particular company, going through a stressful period of time to save free cash flow, to obviously help the ultimate goal of principal recovery as a lender.
So, when you really look at the public market and the public market having these default rates, the other thing that I would urge folks to look at is really the documentation standards. How long does it take you before you get back to the table? Because as you look in the public markets where there's either covenant loose or in many of these, there's no covenants, it really takes a long time before you are really back to the table, because it may be a payment default or maybe a bankruptcy that is showing up on the default index.
As you get into the lower middle market, the core middle market and the upper market and all of these vary, you've put in these bespoke financing solutions and structures whereby you have this documentation standard whereby you're setting up quote unquote bumpers to enable you to get back to the table. So, it may be a covenant default that you have on the financial side. It may be as you go and look through the negative covenant baskets in the documentation, you may be able to govern what that borrower can and cannot do. And that really causes some of this information to not be apples to apples when you're comparing. And it can be a little bit difficult there. But more broadly, the ability to get back to the table early, the ability to put these bumpers into place and have that conversation directly with a private equity firm and work through a negotiation and make sure that that company is on solid footing is extremely important.
So, I'd say it's going to vary manage to manager. It's going to vary depending on market size. It's going to vary depending on documentation. But I think for us as we look more broadly at it, we expect more defaults to happen. But we don't expect those to accelerate at a rate that is going to cause systemic issues more broadly in the market.
We feel like there's always going to be bumps and bruises as this market grows, there's always going to be bumps and bruises due to idiosyncratic risk that one market or one borrower may realize relative to another. Because many of these businesses, especially in the lower middle market and core middle market, are so niche. But I'd say more broadly, we still feel very good about the attractiveness of default rate being low on a relative basis within the private credit market.
CJ Doherty:
And with that, we will wrap up for today. Thank you very much for Garrett for joining me. And best of luck in 2026. I look forward to talking to you again in the future.
Garrett Stephen:
Thanks, CJ. Appreciate you having me.
CJ Doherty:
And thank you all for tuning in. As always, I invite you to check out our private credit news, data and analysis on our Loan Connector, Direct Lending Module and BDC Collateral platforms.
I’m CJ Doherty, subscribe to the Lending Lowdown on your favorite podcast platform.
