During the era of near-zero or negative interest rates, traditional fixed income delivered minimal returns, prompting investors to turn to private credit for higher yields driven by illiquidity and complexity premia. However, the shift to a higher-for-longer interest rate environment has altered the dynamics and appeal of the asset class. The role of private credit in an investor’s portfolio has “changed a bit” over the years, according to Tero Pesonen, Director for Private Equity and Private Credit at Local Tapiola Asset Management.

“When rates were zero or negative, moving to private credit was a conscious choice to get a yield pickup, and the mandate was much narrower,” says Pesonen. “Today, mandates have broadened to capture illiquidity premia wherever they’re best attainable.” He emphasizes that private credit now serves primarily as a return enhancer and portfolio diversifier. “You get different return components, diversification benefits, and non-mark-to-market exposure. But that last part is not a target or design – it’s more of an added advantage.”

“You get different return components, diversification benefits, and non-mark-to-market exposure. But that last part is not a target or design – it’s more of an added advantage.”

Local Tapiola Group is one of Finland’s largest insurance and financial services companies, formed through the merger of Lähivakuutus and Tapiola in 2012. Since 2015, the group’s private equity and private credit allocations have been made through fund-of-fund structures launched approximately every three years for both asset classes. Since 2020, these vehicles have also raised external capital. “It’s a good mix of internal capital and a business-building exercise on the side,” says Pesonen, who oversees manager selection and manages about €2.4 billion invested in third-party private credit funds.

Defining Private Credit: Beyond Direct Lending

While private credit has cemented its position as a standalone asset class and a cornerstone in most institutional portfolios, Pesonen emphasizes the importance of first agreeing on what the term actually means. “More often than not, private credit is almost synonymous with direct lending,” he notes. However, private credit reflects a broader universe. “Direct lending is a big part, but just a part.” Although private credit existed well before the global financial crisis – through mezzanine financing within private equity and distressed debt within hedge funds – “the wave of post-crisis bank regulation truly established direct lending as a standalone asset class.” Today, the private credit market stands at around $1.5 trillion, roughly equivalent in size to the syndicated loan market.

Collaboration Between Banks and Private Credit Managers

International banking regulation increased capital requirements and made many forms of lending less profitable for banks. Direct lending – the largest sub-strategy within private credit – has emerged to fill this gap, with direct lending managers increasingly resembling banks in function. However, banks remain present and increasingly collaborate with private credit players.

“Origination partnerships between private credit managers and banks have been a very natural progression,” argues Pesonen, adding that he’s “quite surprised this trend has only emerged recently – perhaps banks were a bit slow to realize the opportunity.” He believes that the market is well divided, with banks having established partnerships with private credit managers. “There are already large players with very strong market positions.”

“Origination partnerships between private credit managers and banks have been a very natural progression.”

However, Pesonen does not see these origination partnerships as the main driver behind the ‘bigger-getting-bigger’ or ‘winner-takes-all’ trend. Instead, he emphasizes that banks need these partnerships because private credit players provide the necessary capital when clients seek to raise funds, making collaboration essential on both sides. “Buyout firms, in particular, prefer to work with lenders who have substantial capital,” he points out. This makes sense because the buyout strategy is primarily buy-and-build – acquiring a platform and then expanding through further acquisitions. To support this growth, “they need lenders capable of financing those acquisitions.”

On the other side, limited partners (LPs), have recently shown a clear preference for investing in the biggest players. While these firms may not always be the absolute best, their size gives them an undeniable advantage. “This creates a reinforcing cycle: larger firms find it easier to raise capital, and buyout firms are increasingly inclined to work with them, further consolidating their market dominance.”

Direct Lending vs. Syndicated Loans: Increasing Convergence

Private credit has not only caught up with the broadly syndicated loan (BSL) market in terms of scale – now standing at roughly the same size – but direct lending is increasingly beginning to mirror the syndicated loan market in both structure and competitive dynamics. “Direct lending has become a standardized commodity,” says Pesonen. “In many ways, it resembles the syndicated bank loan market from 20 years ago when the banks used to syndicate loans between themselves.” Today, direct lenders are syndicating loans among themselves, particularly in the upper mid-market, which is driving increased price competition and putting downward pressure on spreads.

“Direct lending has become a standardized commodity. In many ways, it resembles the syndicated bank loan market from 20 years ago when the banks used to syndicate loans between themselves.”

At the larger end of the market, loan documentation is increasingly similar to the covenant-light terms common in syndicated loans. “The weaker documentation is also coming into the direct lending market,” notes Pesonen. Borrowers often have a choice between syndicated bank loans and direct lending, creating real competition between the two. “The syndicated loan market typically lacks certain features like acquisition lines suited for buy-and-build strategies, which direct lenders offer.” Nevertheless, “these two options compete closely.” One manager described their upper-market offering as essentially “BSL plus,” highlighting how the boundaries between these markets are increasingly blurring.

“The syndicated loan market typically lacks certain features like acquisition lines suited for buy-and-build strategies, which direct lenders offer. These two options compete closely.”

In 2022 and 2023, the broadly syndicated loan (BSL) market faced a significant disruption due to issues in the collateralized loan obligation (CLO) market, which underpins much of the loan syndication process. “Seventy percent of bank loans end up in CLOs,” Pesonen explains, highlighting how deeply interconnected these markets are. While the spreads on the underlying loans remained relatively stable, the spreads on the AAA tranches of CLOs – the safest liability slices – widened sharply. This spike made funding via CLO liabilities too costly for managers to issue new debt. “The math didn’t work, so the liabilities were too pricey,” Pesonen says. This bottleneck allowed direct lending to temporarily replace the syndicated loan market as the primary financing source. In 2024, “the triple-A spread tightened back to around 110 basis points,” reviving CLO issuance and normalizing syndication once again.

Challenges and Systemic Risk in Private Credit

At the same time, signs of strain are emerging in legacy private credit portfolios. “While transparency remains limited, anecdotally you hear in many places that extended holding periods are becoming common,” Pesonen notes. “Maturities are being pushed back, and amendments are used to delay refinancing because securing new financing has become more challenging.” Although new deals may still offer attractive pricing, older vintages – originated under very different market conditions – are starting to show pressure as exit timelines lengthen and refinancing options remain constrained.

The question of whether private credit poses a systemic risk has been much debated. To that, Pesonen is clear: “My answer is a definite no. This really comes down to the fundamental differences between private credit and traditional bank lending.” He explains that banks historically were highly leveraged – sometimes up to 30 times – and faced significant asset-liability mismatches, borrowing short-term funds while lending long-term. “This imbalance created a fragile system susceptible to runs and liquidity crises.”

“Most private credit vehicles are closed-end funds with long-term capital, and they tend to be hardly leveraged. From a societal and systemic point of view, this makes private credit a far more stable and less risky component of the financial ecosystem.”

“In contrast,” Pesonen continues, “private credit funds operate in a very different environment. Most private credit vehicles are closed-end funds with long-term capital, and they tend to be hardly leveraged.” This structure aligns asset and liability durations much more closely, reducing the risk of sudden liquidity shortfalls. “From a societal and systemic point of view, this makes private credit a far more stable and less risky component of the financial ecosystem.”

In conclusion, Pesonen highlights growing regulatory scrutiny around private credit, noting that while increased regulation could pose new challenges, the broader trend in bank oversight over the past 15 years has consistently moved toward stricter standards. He also emphasizes the role of political uncertainty: “Political shifts could lead to looser bank regulation.” Given that banks and private credit funds effectively compete for the same business, “regulatory changes in one can influence the other.”

This article features in the “2025 Private Markets” publication.