As interest rates have declined and loan margins tightened, some private credit lenders have increasingly turned to back-leverage financing tools to sustain returns.
Back leverage finance structures, where private credit providers borrow from a third party against their assets to finance loans they originate, have enabled lenders to protect returns for their more rate-sensitive accounts in a more challenging and competitive market.
Three Federal Reserve interest rate cuts in 2025, coupled with narrowing loan margins, have compressed interest payments in both the broadly syndicated loan market and the private credit market. Increased competition has been a feature in the private credit space as well, with new entrants and abundant dry powder squeezing margins.
This margin compression has driven lenders to adapt their models and make greater use of back leverage to drive performance. Precise figures for the size of the back leverage market are scarce, but according to Moody’s, bank lending to private credit funds in the US alone climbed to around US$300 billion as of June 2025, with growth outpacing all other bank lending activities since 2016. This number includes traditional portfolio asset-based lending (where loans are secured against underlying assets) and warehouse lending, as well as portfolio net-asset-value facilities (where borrowing is secured against the value of a fund’s portfolio). When used effectively, back leverage has the potential to elevate gains of between 8%-9% into double-digits, according to Bloomberg.
This enables private credit providers deploying capital from investors with a mix of return needs to focus their back-leverage efforts on those accounts which are more rate-sensitive, while leaving the investments of investors with more long-dated lower return expectations (e.g., insurance companies) unlevered.
Private credit firms turn to total return swaps
For private credit lenders in the direct lending market, total return swaps (TRS) have become a popular back leverage tool, helping funds to enhance returns by leveraging their capital with bank balance sheets.
In a TRS, a private credit fund will receive the full financial benefits from a loan that it originates but must commit only a small portion of the capital required to hold the loan, with the difference covered by a bank providing the swap. The private credit fund posts collateral for the loan (which varies but may be around 30% of the loan value) and pays the bank a financing rate for its capital.
TRS structures do require private credit lenders, who bear full risk in the event of a default, to post additional collateral if the value of the underlying loan declines. Nevertheless, these structures offer material upside, as private credit lenders can earn the full return of a loan from a significantly smaller sum of capital.
In addition, loan-on-loan deals have emerged as an effective form of back leverage to lift returns. Private credit lenders utilizing this structure have back levered their deals by using special purpose vehicles (SPVs) to hold underlying loans. These SPVs will then borrow from banks or other fund finance providers (including other non-bank lenders) against the balance of the loans they hold at a lower margin than the underlying loans.
Both the TRS structures and the loan-on-loan back leverage deals allow private credit lenders to recycle capital while still benefitting from the full exposure to the original loans.
Credit quality counts
TRS and loan-on-loan back leverage are valuable tools for maintaining performance, but the bar for accessing these facilities is high. Not all loans will meet the underwriting standards of supporting banks, and lenders must also navigate the varying requirements of different banks and institutions.
For example, back leverage providers that offer TRS facilities will pay close attention to the liquidity and pricing transparency of the underlying loans. These providers will demand more collateral and higher spreads if there are any gaps in these areas. Banks will also apply some of the parameters seen in securitization facilities (such as industry and issuer concentration limits) when assessing TRS back leverage exposures in portfolio deals.
In loan-on-loan deals (where underlying assets will regularly include less liquid middle-market loans with less transparent pricing), back leverage multiples and loan-to-value ratios will be lower, and margins will be higher. Lenders in this space will hold robust dispute rights, with the option to demand a firm bid to test the market for the pricing of the asset, or to require a third-party valuation.
A shifting market for back leverage
Back leverage will remain a crucial tool for direct lenders, but disruption in private credit markets is reshaping how banks assess their back leverage books.
The high-profile defaults of Tricolor and First Brands Group, and concern around private credit’s exposure to the software sector, where the risk of an AI disruption looms large, have unnerved investors. This has driven a sharp rise in redemption requests from publicly-traded private credit vehicles. Some banks are pausing lending to private credit firms, at least in the short term, to assess where the market will land following this period of uncertainty.
The back leverage market is by no means shut, and activity is steady, but credit committees are asking tougher questions and provision is likely to concentrate around the highest-quality assets.
