The Big Idea
A new picture of private debt funds with plenty of dry powder
This material is a Marketing Communication and does not constitute Independent Investment Research.
Private debt funds have taken a small step out of the shadows lately, thanks to the Fed, and they look well equipped to handle the credit stresses and shareholder redemptions in the headlines this year. Assets have started to grow again after shrinking in the first quarter, and the funds as a group show a deep pool of capital and plenty of dry powder. The capital should help funds absorb plausible losses and the dry power should let them keep supporting existing clients and possibly lending to new ones.
The new picture comes in the Fed’s latest Financial Accounts of the United States released September 11, which includes private debt funds for the first time. The report shows total fund assets and liabilities.
Assets rise on new lending
Total assets rose to $935 billion through June, just below their peak at the end of last year (Exhibit 1). Holdings remain dominated by private loans to US companies (56%), corporate equity (19%) and debt securities (13%). Private loans to foreign companies, cash, money market funds and miscellaneous assets round out the holdings.
Exhibit 1: Assets of private debt funds grew in the second quarter of 2026
Note: private debt funds include senior and subordinate direct lending, opportunistic, asset-backed lending and other unclassified private debt funds.
Source: Federal Reserve, Santander US Capital Markets.
The uptick in assets looks like new lending since the funds on average marked down the value of their loans in the first quarter. The Fed report shows fund loans at both at fair value and cost, and fair value dropped for the second straight quarter to 97.9% of cost (Exhibit 2). Funds last reported similarly low marks as the Fed hiked in 2022 and 2023. The rise in assets suggests funds started making new loans after a rough first quarter when concerns about AI, loans to software companies and investor redemptions stalled private debt markets.
Exhibit 2: Lower marks on loans suggest asset growth came from new lending
Source: Federal Reserve, Santander US Capital Markets.
Assets funded mainly with equity
Private debt funds also continue to fund their assets mainly with shareholder equity and modest amounts of debt, giving them significant ability to absorb losses on loans or other assets. Shareholder equity made up 55% of fund liabilities at the end of June (Exhibit 3). Loans from banks and other lenders made up only 25% with miscellaneous liabilities filling the gap. It would take catastrophic levels of loan default and loss to wipe out fund equity.
Exhibit 3: Private debt funds hold 55% equity, a cushion against loss
Source: Federal Reserve, Santander US Capital Markets.
Lots of dry powder
The new Fed numbers also show a striking amount of dry powder at the private funds—capital committed by limited partners but not yet drawn or invested. At the end of June, funds held $0.62 in dry power for every $1 in par value of loans (Exhibit 4). The dry power should give private funds plenty of capacity to manage redemptions, support existing clients and potentially lend to new ones if redemptions taper off. It is hard to know whether the dry powder is included in shareholder equity since the treatment often depends on funds’ legal documents. The Fed report suggests it is not included in equity.
Exhibit 4: Private funds held dry power equal to 62% of par value in loans
Source: Federal Reserve, Santander US Capital Markets
Consistent with earlier work on private debt funds
The new picture of private debt funds from the Fed is consistent with work from a team lead by Gregor Matvos at Northwestern University that reviewed most of the private debt fund industry. The team found that most funds have equity equivalent to 65% to 80% of total assets. Debt is moderate and mainly reflects bank credit lines. The team also looked at fund portfolios and found them well diversified across industries and geography.
Market implications
Earlier work on private debt funds had consistently pointed to big capital cushions and limited leverage, implying the funds would probably survive the credit and redemption concerns that percolated up earlier this year. But their ability to support existing and new clients has been unclear until the Fed’s latest numbers. The amount of dry powder shown in the Fed’s tally looks like significant untapped lending capacity, likely making private debt funds ongoing players in leveraged lending markets. Instead of having to preserve cash and slowly hand over current clients to other lenders as those clients needed to refinance or take out new loans, private funds look equipped to keep current clients and grow.
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The view in rates
The market is pricing another 77 bp of Fed tightening by June next year with some potential for more over the balance of 2027. Chalk it up to a unanimous vote for the last hike at the FOMC and signals of more to come. The dots also showed a rise in expected inflation, unemployment above equilibrium and an economy running above its potential. Rates have reflected it across the curve.
The 10-year Treasury note will likely spend all of this year and next above 4.50%. Technology companies’ and government demand for cash is likely to keep longer-term rates high even if the Fed dampens inflation. If anything, tech demand to borrow is likely to get even higher next year and put more pressure on real rates. Only a break in the AI rally could hit credit and the broader economy and lead recession to drag the 10-year rate below 4.50%, but that possibility looks remote.
Key market levels:
- Three-month term SOFR traded Friday at 400 bp, up 14 bp in a week
- The 2-year Treasury note traded Friday at 4.74%, up 11 bp in a week. The 10-year note traded at 5.00%, up 4 bp in a week.
- The Treasury yield curve flattened sharply after the FOMC with the 2s10s spread trading Friday at 25 bp, 8 bp flatter in a week, and 5s10s spread at 47 bp, 10 bp flatter.
- The 10-year inflation breakeven traded Friday at 232 bp, down 4 bp in a week. The 5-year, 5-year forward breakeven was 228 bp, down 2 bp. The 10-year real rate ended the week at 268 bp, up 8 bp.
The view in spreads
The supply-demand balance looks neutral to bullish for corporate and structured credit—except for technology—and neutral to negative for MBS. Fixed income ETFs and mutual funds keep seeing strong inflows and investing the new cash in risk assets. Insurers continue to issue annuities and buy corporate and structured credit. Foreign investors are buying more US credit than government debt. But credit markets face heavy financing needs for capital investment in technology. MBS net supply remains low, but the expected steady demand from Fannie Mae and Freddie Mac has not materialized. Carry will likely drive returns. Stay overweight MBS and favor higher coupons to add carry and reduce spread duration. Stay overweight corporate credit overall but underweight technology.
The Bloomberg US investment-grade corporate bond index option-adjusted spread traded Friday at 75 bp, 3 bp tighter in the last week. Nominal par 30-year MBS spreads to a blend of 5- and 10-year Treasury yields were 117 bp, 2 bp wider. Par 30-year MBS Treasury option-adjusted spreads closed at 32 bp, wider by 2 bp in the last week.
The view in credit
The picture here remains surprisingly steady. Most credit is fundamentally sound, although persistent high rates should put pressure on more leveraged balance sheets. Large companies have healthier balance sheets than smaller ones. Middle- and higher-income consumers also carry relatively little debt and have strong liquidity and wealth. Bank lending to nonbank financial institutions, including private debt funds and business development companies, continues to grow. Credit measures for nonbank financial lending remain stronger than those for traditional bank lending, such as commercial and industrial loans.
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