Introduction
Following the headlines last year surrounding the Tricolor and First Brands bankruptcies, several prominent voices in the financial industry questioned the outlook for private credit. Commentators raised concerns that the market’s relative opacity could be masking deeper stress than what’s visible in publicly available data. Most frequently cited perhaps were J.P. Morgan CEO Jamie Dimon’s remarks that likened credit issues to “cockroaches,” or the remarks of other commentators that indicated that the bankruptcies surfacing to date may not be idiosyncratic events, but early indicators of broader, systemic issues for the asset class.
Some of the skepticism has merit. Private credit’s rapid growth initially occurred during a period defined by historically low interest rates, abundant capital looking for opportunities, and exceptionally strong private equity activity. In that environment, lending conditions were more accommodative, and many deals were structured with assumptions that may not hold today. With interest rates now higher and financial conditions tighter, business loans that were underwritten during that easier regime could face increasing pressure.
But, despite these recent headwinds, direct lending — which focuses on providing loans to private businesses outside the traditional banking channel and is the most prominent sub-asset class of the private credit universe — has remained relatively resilient. Credit events in direct lending have thus far been contained, and while credit metrics for the market have weakened to a degree, they have shown stability in more recent periods. These headlines do however underscore the need for discernment. Investors can mitigate many of these risks while maintaining exposure to a market that has matured, is diversified across thousands of active corporate borrowers, and continues to evolve with the needs of its market participants.
Recent headlines
Against this backdrop, the latest headlines in private credit offer valuable insights into how these risks and dynamics are playing out in real time, shaping both market sentiment and investor decision-making. As assets under management have increased, competition for lending to the most attractive borrowers has surged, contributing to some erosion in lender protections. Much of the recent commentary has focused on specific structural features that may obscure emerging stress as a result: payments-in-kind (PIK) and liability management exercises (LMEs). The growing prevalence of both reinforces why manager experience and strong underwriting matter.
PIK can be thought of as allowing interest to accumulate rather than being paid as scheduled, providing short-term relief for cash-strapped companies, but creating more risk for lenders. It’s not inherently problematic and can even be beneficial when used intentionally. During the height of the COVID-19 pandemic, many otherwise viable businesses were forced to close their doors and needed temporary relief. When PIK is part of the original loan structure, pricing can reflect the added risk of deferred cash flow. For investors, rising PIK prevalence — especially via amendments — warrants close scrutiny, as it can signal unanticipated borrower distress or near-term liquidity challenges while amplifying downside risk. Similarly, LMEs, which are strategies used by companies to restructure their debt or raise additional capital, can be constructive as they can help companies navigate periods of stress. However, certain transactions can materially weaken lender protections and recovery prospects, particularly when borrowers exploit flexibility in credit agreements at the expense of the lender. The expertise of a well-seasoned investment management firm can help to mitigate risks associated with these techniques.
The risk environment: Selective or systemic?
Such bespoke terms and complex structures of private loans introduce other well-flagged sources of risk: illiquidity and opacity. Private loans rarely trade on secondary markets, and managers have considerable discretion in how they are priced. This has driven growing concerns that some of the valuations/pricing on these loans may be overly optimistic. That debate has intensified recently after several funds made headlines for being forced to take sharp write-downs when problem loans soured, adjusting asset pricing that had previously been valued at or close to their original issue price. High-profile failures like First Brands have reinforced criticism that stale or inflated valuations can delay recognition of borrower stress and hide growing risks in a rapidly growing market.
That said, traditional private credit is typically a buy-and-hold strategy, so interim marks often matter less than the ultimate outcome: loans are either repaid or they aren’t. Even so, inaccurate valuations can still create real issues for certain investors, particularly regulated institutions or leveraged funds that depend on asset values for compliance or financing along the way. Given that many of these funds provide for some periodic liquidity (typically quarterly), funds that are mismarked may disadvantage those investors who stay in the fund while benefiting those who redeem their investments at inflated prices.
The data to date suggests that stress in private credit has thus far been selective rather than systemic. The increased prevalence of PIK and LMEs does point to pockets of weakness, but default rates have remained contained, at least thus far. Illiquidity remains a key risk that investors should be aware of, though proponents of private credit argue this as a positive feature for the market. Many private credit funds are backed by long-term, contractually locked-up capital, providing more stability in the capital base compared to traditional bank lending. This structure reduces the risk of disorderly selling and contagion and affords managers greater flexibility to work through periods of stress.
Private credit is now an integral part of the broader credit market, offering both risks and opportunities, and the boundary between public and private markets has blurred. Private credit now rivals leveraged loans and high-yield bonds in market size, and borrowers are increasingly financing across all three markets based on practical considerations such as cost, flexibility, speed, and certainty of execution. This convergence reflects the maturation of private credit, suggesting that while risks are inevitable, the structure of private credit funds could allow future stresses to be more likely managed than magnified.
Key takeaways: Risk awareness and management
Investing has always been about trade-offs: higher returns generally require higher risk. Private credit is no exception, and the name itself says it plainly: this is credit, and default risk is real. Like any asset class that bears risk, prudent risk management is key.
For investors, having a clear understanding of risks, sizing allocations appropriately, and remaining diversified across individual holdings is important. Monitoring credit metrics such as nonaccruals, PIK exposure, and interest coverage is essential. Collectively, these considerations illustrate why partnering with skilled investment managers that have demonstrated a solid long-term track record of effective underwriting and navigating the credit cycle is critical. As market tailwinds moderate, performance dispersion is likely to increase, creating opportunities for skilled managers to differentiate themselves. Private credit has earned a role in diversified portfolios, and for disciplined investors, this may result in long-term rewards for well-managed risk.
Past performance does not guarantee future results. All investments include risk and have the potential for loss as well as gain.
Data sources for peer group comparisons, returns, and standard statistical data are provided by the sources referenced and are based on data obtained from recognized statistical services or other sources believed to be reliable. However, some or all of the information has not been verified prior to the analysis, and we do not make any representations as to its accuracy or completeness. Any analysis nonfactual in nature constitutes only current opinions, which are subject to change. Benchmarks or indices are included for information purposes only to reflect the current market environment; no index is a directly tradable investment. There may be instances when consultant opinions regarding any fundamental or quantitative analysis may not agree.
Plante Moran Financial Advisors (PMFA) publishes this update to convey general information about market conditions and not for the purpose of providing investment advice. Investment in any of the companies or sectors mentioned herein may not be appropriate for you. You should consult a representative from PMFA for investment advice regarding your own situation.
