The Outside Option Is Not Universal
Private credit and leveraged loans are two major ways that below-investment-grade, middle-market companies obtain financing. The question this series examines is narrower and more consequential than whether private credit is growing: when private-credit conditions tighten, which borrowers can actually move to the leveraged-loan market, and which borrowers have no comparable route? The answer helps distinguish a market that is large from a market that is available to a particular firm.
The Federal Reserve describes private credit (PC) and leveraged loans (LL) as serving broadly similar firms, often with revenues between $10 million and $1 billion. The two markets were each about $1.4 trillion at the end of 2025 under the note’s measure. Together they represented about 45% of lending to private nonfinancial corporations, while a footnote gives a lower figure of about 20% when the denominator is all nonfinancial corporations. Those percentages are not competing estimates: they answer different questions about what counts as the comparison universe. Either way, the markets are large enough that a disruption in one can affect more than a narrow corner of corporate finance.
But size is not the same as substitutability. A borrower can be in an industry served by both markets and still be able to reach only one of them. The Federal Reserve’s central finding is conditional: larger middle-market firms that have access to both markets tend to move toward private credit when leveraged-loan conditions tighten and move back when leveraged loans become more accommodating. Smaller firms have less capacity to substitute and are more exposed when private-credit financing itself becomes less available.
A tightening is a borrower problem, not only a market problem
Consider two firms that have similar purposes for a new loan—say, refinancing debt or financing an acquisition. If both have previously borrowed in the PC and LL markets, a change in relative terms creates a choice. They may compare price, execution speed, covenant flexibility, maturity and the probability that a lender will approve the transaction. A firm that has borrowed only through private credit faces a different situation. When its familiar lenders pull back, the issue is not which of two attractive offers is better. It is whether an alternative lender will accept the firm at all.
That distinction is easy to miss when market commentary treats PC and LL as two large pools of capital. At the market level, the pools overlap. At the firm level, access is uneven. A PC tightening can therefore be absorbed partly by substitution for some borrowers while becoming a direct financing constraint for others. The same headline—private-credit investors are less willing to fund new loans—does not imply the same outcome for every company.
This is why the phrase “outside option” is useful. It does not mean a guaranteed loan waiting on a shelf. It means that the borrower has a credible path into another financing system, supported by the scale, information, relationships and loan characteristics that system requires. The path can still be more expensive or slower than the borrower would prefer. It can also disappear if the alternative market tightens at the same time. But without that path, market-wide substitution is only an aggregate possibility, not a firm-level solution.
The Federal Reserve’s borrower histories make the asymmetry visible. Among firms that issued debt between 2020 and 2025, about 41% of larger firms had accessed both markets, compared with about 25% of smaller firms. Smaller firms were much more likely to be classified as PC-only. These are not shares of loan dollars, and they do not prove that size itself causes access. Size stands in for several capabilities at once: the ability to support a larger syndicated loan, provide information to a broad investor base, maintain sponsor and bank relationships, and meet the conventions of a more standardized market.
Similar borrowers, different financing systems
Private credit and leveraged loans overlap because they fund similar kinds of corporate activity. Both commonly provide medium-term, floating-rate financing to highly leveraged firms. LBO and M&A transactions, refinancing and general corporate purposes appear in both markets. That overlap explains why a borrower can sometimes switch. It does not erase the institutional differences that determine whether the switch is possible.
Private-credit loans are commonly originated and held by private debt funds, business development companies and related vehicles. A loan may be negotiated bilaterally or with a small group of lenders. The lender holds more of the relationship and can offer bespoke covenants, move quickly and renegotiate with fewer parties. The trade-off is that the loan generally has no active secondary market, and its value is based on internal or third-party models rather than a continuously traded price. Funding conditions depend on committed capital, flows into private-debt funds, BDC equity issuance and the leverage that banks provide to those vehicles.
Leveraged loans are more often arranged, underwritten and syndicated by banks, then distributed to institutional investors through broadly syndicated loan collateralized loan obligations, mutual funds, exchange-traded funds, insurers and other asset managers. Standardization and distribution make the market more liquid and allow market prices to update frequently. They also make financing conditions sensitive to the appetite of the investors who buy and trade the loans. Banks retain parts of some loans and provide revolving facilities, so their role is not simply to pass a borrower from one investor to another.
These structures create different kinds of flexibility. Private credit may be more adaptable once a relationship exists: terms can be tailored and a smaller lender group can negotiate a modification. Leveraged loans may offer a broader funding base and more visible price discovery when institutional demand is strong. Neither statement is a permanent ranking. A private-credit loan is not automatically cheaper or safer, and a liquid market can become difficult when banks reduce underwriting or investors demand a higher risk premium.
The borrower data show why these structural differences become an access question. In the Federal Reserve’s comparison of 2025 loan issuances, the median PC borrower had revenue of $223 million, compared with $902 million for the median LL borrower. The PC borrower was also more leveraged: median debt was five times EBITDA, compared with 3.2 times for LL borrowers, while average interest coverage was 2.2 times versus 3.7 times. The typical PC loan was much smaller—$20 million versus $275 million—and the reported median spread over SOFR was higher, 500 basis points versus 400. These are sample medians, not a price list or a rule that a particular firm must fit one market. They do show that the two systems often meet borrowers at different points on the scale and risk distribution.
The rating comparison carries its own caution. Most PC borrowers lack public ratings, so the Federal Reserve uses estimated ratings for that group, while the LL figures are based on public ratings of loans. The categories are therefore not perfectly equivalent. Still, the pattern is consistent with the broader access story: PC serves more borrowers with limited public information and weaker measured coverage, while LL’s standardized distribution relies more heavily on a borrower profile that can be evaluated by a broad investor base. A company may value PC precisely because its circumstances do not fit the usual syndicated template. That same fact can make an LL switch difficult when PC becomes less available.
This is also why a lender’s willingness to renegotiate should not be confused with a borrower’s ability to change lenders. A private-credit fund may be able to alter a covenant with a small group of existing creditors, but a PC-only firm that needs new money still depends on the fund’s capital and underwriting appetite. Conversely, a firm may find a deep LL investor base but face a more standardized process and a higher bar for distribution. Flexibility inside one relationship and portability across markets are different capabilities.
The important point is that the two markets can tighten for different reasons. In LL, a reduction in bank underwriting or a retreat by institutional investors can make syndication harder. In PC, a decline in committed capital, investor flows, BDC equity issuance or vehicle leverage can reduce the supply of new loans. A borrower can move only if the alternative system is both open and compatible with the borrower’s needs.
The outside option is a capability
The Federal Reserve’s evidence points to a practical conclusion before the detailed mechanisms are examined: the question is not whether private credit and leveraged loans overlap in the aggregate, but which firms sit in that overlap. In the overall borrower sample, roughly one-third of firms had accessed both markets, roughly one-third were LL-only, and the remaining group was PC-only. The balance changed sharply by size. Larger firms were distributed across both markets, while small firms were concentrated more heavily in private credit and were less likely to move from PC to LL.
The switching percentages must be read carefully. The Federal Reserve counts changes in a firm’s financing source across consecutive loans, using firms with a new loan in the trailing twelve months. The LL-to-PC and PC-to-LL rates are calculated with reference to firms that previously borrowed in the origin market. A high LL-to-PC share therefore says that many eligible LL borrowers moved into PC during a period of tight LL conditions; it does not say that the same share of all middle-market firms could move in the opposite direction during a PC shock. The observation covers firms receiving new loans, not every company seeking refinancing or being denied credit.
This distinction sets the central tension for the rest of the series. Private credit can act as a backstop when a borrower has the ability to reach it and when its funding base remains available. It cannot automatically backstop every borrower who loses access to another market. A borrower’s history, size, information, leverage and relationships shape the route before the relative price of the two markets can even be compared.
The next step is to follow the two routes more closely: who supplies the capital, who makes the underwriting decision, how the loan is distributed, and where liquidity or renegotiation enters the process. Once those differences are visible, the later evidence about borrower eligibility and switching becomes a question about mechanisms rather than a surprising pattern in a chart.