Speaking Thursday at the Milken Institute Asia Summit, Matthieu Boulanger, head of Europe at HPS Investment Partners, said there's been increased competition for smaller funds focused on lower middle market lending. "You've seen a lot of spread compression for the last few quarters."

HPS’ larger check sizes for upper middle market and large-cap opportunities, where there are fewer competing managers, have insulated it to some degree. The bigger threat for the firm is the public credit market, says Boulanger, noting that the illiquidity premium for private credit has compressed dramatically in recent years. "It was once as much as 350 basis points," Boulanger said. "Right now, it's more like 1 - 1.5 percent."

And, like Apollo, HPS is pushing deeper into corporate investment-grade credit. "Some of the attributes of the middle market private credit business that we know—certainty of executions, customization of terms, etc.—apply to this market as well," said Boulanger.

On the more competitive lower end of the market, there's growing pressure on managers to chase yield at the expense of credit quality.

"That's not to say that you are not attracted to more complex situations like complex credit, complex structure, complex story, but you need to be paid for it," said Boulanger.

"The unhappy middle is where you see one of these complex situations being priced like a regular financing. This is where you see differences between managers who have experience differentiating between the two."

Default risk is already a concern. Patrick Dennis, co-deputy managing partner of Davidson Kempner Capital Management, says true private credit default rates are now approaching 3 - 5 percent when taking into account covenant breaches and credit agreement modifications for struggling borrowers.

Many managers have chosen to avoid discount payment default and instead convert cash coupon to payment-in-kind or to extend payment terms. "What we would describe as kicking the can down the road a bit between borrower and lender," added Dennis.

Per Proskauer's Private Credit Default Index, which tracks conventional defaults and selective defaults (covenant breaches or amendments in anticipation of a default), the overall default rate for senior secured and unitranche loans rose to 2.71 percent in the second quarter, marking the third consecutive quarter of increases.

"From a severity perspective, I think this is the biggest risk in the market that we're trying to evaluate," said Dennis. "Over the next twelve months, we really do think defaults are kicking up. From our perspective we really do want to ensure there is some level of margin of safety of what we're underwriting to."

That may lead to a particularly challenging environment for those newer managers who may be starting out with less robust origination capabilities and a relative lack of workout expertise.

One bright spot for lenders is the growing opportunity in asset-backed finance, which, says Dennis, "is a market that has gone from esoteric to essential in LPs portfolios over the last 24 months." Part of the excitement is the strategy's attractive returns profile (both HPS and Davidson Kempner are targeting high single-digits to mid-double-digits), as well as from managers who feel their portfolio may now have too much exposure to middle market lending.

Within asset-backed finance, opportunities are broadly split between financial assets, such as mortgages and consumer debt, and hard assets, like aircraft or equipment leasing, real estate or infrastructure credit, and niches like intellectual property (e.g. music rights).

As with much of private credit’s growth, traditional banks have historically serviced the asset-backed finance market and have tried to hold onto it, but there's now a growing push from direct lenders to carve out their own foothold.