Hi there,

There is one topic currently dominating private markets conversations: what is wrong with private credit? 

Private credit generally refers to lending by non-bank entities to privately held companies outside of public markets. Institutional investors have benefited from this growing market for years, attracted by its steady returns and low volatility. More recently, however, the market has come under scrutiny as economic conditions have become more uncertain and the quality of certain credit exposures is being reassessed. 

In today’s edition, we cover what private credit is and trace its evolution from a pre-2008 niche discussed primarily among experienced professionals into a $3 trillion asset class. We then examine why private credit is hitting some turbulence and how the same features that once supported its growth are now revealing vulnerabilities. 

Let’s get started. 

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As outlined above, in private credit, non-banking entities such as private funds, asset managers and specialty finance firms lend to private companies. But this raises a question: why would a non-bank firm enter into the lending business in the first place? 

Banks typically operate under strict regulatory frameworks that limit the amount of risk they can assume. As a result, many smaller, mid-sized, or higher-growth companies fall outside traditional lending criteria.

At the same time, these companies are often too small to access public debt markets and may require faster execution and more flexible structures. Private credit funds have stepped in to address this gap.

Private credit funds typically charge higher interest rates than traditional banks because they take on more risk. They also offer more flexibility in terms of loan structure, repayment schedules and repayment terms. 

For investors, this translates into higher yields compared to traditional fixed-income instruments. For borrowers, the appeal lies in speed, flexibility and execution certainty.

It is also important to note that private credit is not a single, uniform product. Broadly, it can be divided into two core approaches:

Private credit was not always as prominent as it is today. Prior to 2008, corporate lending was largely dominated by traditional banks, with private credit remaining a relatively niche segment of finance.

The Global Financial Crisis fundamentally altered that dynamic. It exposed the risks associated with excessive leverage and complex financial products, prompting regulators to impose tighter constraints on banks.

For instance, under Basel III, banks are required to hold more capital against higher-risk exposures. In the United States, the Dodd-Frank Act introduced additional restrictions on risk-taking and lending activity.

As banks reduced their exposure to riskier borrowers, private credit firms stepped in to fill part of the financing gap. Over the following 15 years, private credit expanded rapidly. A prolonged low interest rate environment made returns in the 8% to 12% range particularly attractive relative to traditional fixed income.

As capital flowed into the sector, it grew nearly tenfold, from approximately $310 billion in 2010 to c. $3.5 trillion by the end of 2025. To put all that into perspective, the five largest managers alone, Apollo, Blackstone, Ares, KKR, and Carlyle, grew their combined credit AUM by 174% between 2020 and 2025, from $750 billion to over $2 trillion. S&P Global projects the combined AUM of these funds will top $3.3 trillion by 2029.

A key consideration is that much of this growth occurred during an unusually supportive macro environment. The asset class has yet to be fully tested across a complete credit cycle, and several of the conditions that supported its expansion are no longer present.

For an extended period, private credit reported default rates below 2%, reinforcing a perception of stability among investors. However, these figures did not always capture the full picture of underlying credit quality.

Fitch Ratings recently reported that the actual default rate in its U.S. Privately Monitored Ratings portfolio rose to 9.2% in 2025, up from 8.1% in 2024. Among smaller borrowers with EBITDA below $25 million, the rate increased to 15.8%.

Pressure is also visible beyond defaults. The IMF found that 40% of private credit borrowers are generating negative free cash flow, meaning they are consuming more cash than they produce. That figure stood at 25% in 2021.

Another indicator is the rise in Payment-in-Kind (PIK) structures. Under these arrangements, when a borrower is unable to pay interest in cash, the unpaid amount is added to the outstanding principal balance. As a result, the loan may remain current on paper, while the borrower’s debt burden continues to rise.

By 2025, around 8% of BDC investment income was derived from PIK. More concerning still, PIK structures were previously associated mainly with the riskiest junior loans. But they are now appearing more frequently in senior secured debt, which has traditionally been regarded as the safer part of the market.

At the same time, slower private equity exit activity is adding pressure. Longer holding periods mean loans remain outstanding beyond initial expectations, contributing to broader system strain.

LP distributions have fallen below 15% of NAV, well below the historical average of 25-30%. According to Bain's 2026 Global PE Report, distributions as a share of NAV remained at just 14% in 2025, a level not seen since the 2008 financial crisis (see below).

To understand a key risk emerging in private credit, it is necessary to examine how private equity funds value their portfolios.

Each PE fund tracks the total value of the companies it owns. When we add up the estimated value of all portfolio companies and subtract the debts, what we get is the Net Asset Value, or NAV. That is the fund’s net worth at any given point in time.

But how do we know how much these portfolio companies are worth? 

Unlike public equities, these valuations are not determined by daily market pricing. Instead, funds rely on internal models based on assumptions regarding future growth and exit prices. 

For instance, a fund acquires a company for 100 today and assumes it will sell for 200 in five years. Using a 10% annual discount rate, the present value of that 200 is roughly 135. So the fund marks that investment at 135 in its NAV today.

Now, under unfavorable conditions, it can happen that the actual value is 120 instead of 200. The fund marked it at 135 based on an optimistic assumption. If exits are frozen, similar to what’s happening now, these assumptions cannot be tested against real transaction prices.

When PE exits are largely frozen, funds cannot distribute to LPs, who are eagerly waiting for cash distributions. Funds that were supposed to return capital by 2023 or 2024 are still sitting on unsold companies. LPs like pension funds, which have real obligations to meet, have all the reasons to get impatient. 

To address the stalemate, GPs found a solution: NAV lending. 

Instead of selling at today's lower prices and buying more time for better market conditions, they borrow money against their portfolio's NAV and use that cash to pay LP distributions. 

This is NAV lending, which has grown rapidly at a 30% annual rate between 2019 and 2023. Outstanding NAV loans are now estimated at $225 billion, according to Ares Management. In 2025, a record $12.9 billion of new NAV lending funds were launched, including the largest NAV lending fund ever, 17Capital's $5.5 billion vehicle.

So, where is the problem we are talking about? Let me explain.

If a fund borrows against a NAV marked at 135, but the true value of the asset is closer to 120, the loan has effectively been underwritten against an inflated base. In that case, leverage is higher than it appears.

Now extend that dynamic across an entire portfolio of 10 or 15 companies. Then extend it across hundreds of funds that acquired assets at elevated valuations between 2019 and 2021. Many of those portfolios may still be marked above where they would clear in an actual sale, and some have already borrowed against those marks.

If valuations start to reset downward, parts of that borrowing structure can come under pressure. Funds may then be forced to sell assets at distressed prices to meet obligations or repay lenders. That selling can pull down comparable valuations elsewhere, adding pressure across the market.

NAV lending itself is not inherently problematic. It can support acquisitions, provide liquidity, and stabilise portfolios. The concern arises when it is used extensively against valuations that may not hold under market scrutiny.

Recent redemption activity suggests that liquidity pressure is becoming more visible. In Q1 2026, Blackstone's BCRED received withdrawal requests worth $3.7 billion, which is 7.9% of its assets, well above its standard 5% quarterly cap. In response, Blackstone responded by raising the cap to 7% and committing $400 million of firm and employee capital to help meet withdrawals

In March 2026, BlackRock limited withdrawals from its $26 billion HPS Corporate Lending Fund after investor redemption requests (9.3%) exceeded the fund's quarterly liquidity cap (5%). 

At Cliffwater's $33 billion Corporate Lending Fund, investors sought to pull a staggering 14% of shares. The fund capped redemptions at 7%, its regulatory maximum. 

Does this point to a 2008-style event?

Not necessarily.

But that should not be mistaken for a clean bill of health. Unlike banks in 2008, private capital vehicles are funded with longer-duration capital and generally use less leverage, which reduces the probability of an abrupt systemic shock.

The greater concern is a slower repricing cycle in which overstated valuations, weak exits, and additional borrowing reinforce one another over time. The question is if that results in a contained correction or a broader dislocation.

That’s the newsletter for today!

As always, feel free to share feedback or suggestions on future topics you’d like covered.

Until next time,
PE Bro

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