(Image: The Breach of the Saint Anthony’s Dike near Amsterdam, Jan Asselijn, 1651)
“For some of the older deals, there’s stress building up in portfolios that will manifest in different ways. And then the last step is you’ll see capital-D defaults.”
– Armen Panossian, CEO, Oaktree Capital Management, December 2023
Private credit was supposed to be a better solution: filling a gap in the lending market and offering investors high floating-rate yields, lower volatility, and diversification. While public markets move on every Fed utterance and tariff headline, the “private” in private credit implied something steadier — bespoke loans, negotiated terms, patient capital, sophisticated lenders who actually knew their borrowers. For most of the fifteen years following the 2008 financial crisis, this was largely true. The asset class grew from roughly $460 billion in 2013 to over $3 trillion 2025 — a pace that made it one of the fastest-growing segments in global finance, filling the lending void left when post-crisis bank regulations pushed traditional lenders away from leveraged and middle-market borrowers. Returns were strong, volatility was low, and the pitch was simple: equity-like yields with bond-like downside protection.
But that premise is now being tested. And the early results are not reassuring.
HOW PRIVATE CREDIT GOT HERE
The story of private credit is, essentially, a story about regulatory gaps. After the 2008 crisis, the rules made it expensive for banks to hold leveraged loans to mid-market borrowers. Non-bank lenders — private credit funds, Business Development Companies, insurance company lending arms — stepped into that gap. They offered what banks couldn’t: speed, flexibility, confidentiality, and a willingness to hold the entire loan on their own books rather than syndicate it to a fragmented group of investors.
What made the structure look safe was the combination of floating rates and covenants. Floating rates meant private credit funds benefited mechanically as interest rates rose after 2022, while fixed-rate public bond investors were being destroyed. And covenants — the detailed restrictions embedded in private loan agreements — were supposed to give lenders early warning of borrower distress and a seat at the table before a default occurred. The pitch worked. From 2020 to 2025, assets under management grew by roughly 50% (from $2 trillion to $3 trillion). Blackstone, Apollo, Ares, Blue Owl, and KKR all built enormous private credit franchises. The five largest alternative asset managers now hold a combined $1.5 trillion in perpetual capital — roughly 40% of their combined AUM.
But the structure also has some major issues that only become visible when the credit cycle turns. And the credit cycle is turning.
THE STRESS SIGNALS
Private credit stress doesn’t look like public market stress. There are no real-time spreads to watch, no index that prices daily. The signals are subtler: covenant waivers, maturity extensions, and importantly, the rising use of payment-in-kind — or PIK(1) — structures.
PIK loans allow borrowers to add interest owed to the principal balance rather than pay it in cash. In a healthy company with strong growth, this can be a sensible tool — conserving cash for reinvestment while debt compounds (ideally, of course, at lower rates than the ROI of that reinvestment). But when a company that has been making cash interest payments switches to PIK, it is almost never a good sign. It is a sign that cash flow can no longer service the debt. PIK usage became widespread in the pre-2008 leveraged buyout boom — in 2007, 20% of buyout firms had issued PIK debt — and its resurgence is one of the clearest leading indicators the industry has of deteriorating credit quality. Public BDCs(2) are now receiving an average of 8% of investment income via PIK, up from roughly 4% five years ago. In some portfolios, PIK accounts for 20% of total loans.
The headline default rate in private credit has remained below 2% for several years. But as S&P Global’s With Intelligence documented, once selective defaults and so called “liability management exercises” — debt-for-equity exchanges, covenant waivers, maturity extensions — are included, the true default rate approached 5% through the first nine months of 2025. While defaults are currently at about 5.5%, direct lending in particular could rise as high as 8%.
The rating agencies are also confirming the direction of travel. Morningstar has reported that downgrades within private credit outnumbered upgrades by 3.3 times in the first six weeks of 2026 — a ratio that has been worsening for eight consecutive quarters. Among borrowers active for more than one year, approximately 12% have cash flow below zero and 13% have interest coverage ratios below 1, up from 7% and 8% respectively just one year ago. Fitch went so far as to stamp a “deteriorating” outlook on BDCs in late 2025. None of these represent a systemic crisis. Together they represent a market repricing against assumptions formed in a different environment.
Just yesterday — March 24, 2026, as this note is published — came the clearest single signal yet. Moody’s downgraded FS KKR Capital Corp, a $14 billion publicly traded BDC managed jointly by KKR and FS Investments, from Baa3 to Ba1 — stripping it of investment-grade status and pushing it into junk territory. Bloomberg called it “a rare occurrence” in private credit. The grounds were unambiguous:
- Non-performing loans had climbed to 5.5% of total investments, one of the highest rates among rated BDCs;
- PIK income accounted for 14.7% of total investment income in 2025, more than double the peer median of 6.3%; and
- The fund posted a net loss of $114 million in Q4 and earned just $11 million for all of 2025. Moody’s also flagged significant markdowns on loans not yet classified as non-accrual, including a $233 million position in software platform Medallia now carried at $185 million.
FSK shares have fallen more than 31% year-to-date. And the downgrade matters beyond FSK itself: because BDCs issue debt to enhance returns, a junk rating directly raises borrowing costs, compresses future returns, and limits financial flexibility — a possible downward spiral that is difficult to reverse.
The high-profile bankruptcies of late 2025 — auto-industry firms Tricolor and First Brands among them — illustrated a particularly uncomfortable dynamic. In the case of First Brands, BlackRock and other private lenders had marked the debt at 100 cents on the dollar until shortly before writing it to zero. This is not an anomaly — it is a structural feature of a market where loans trade infrequently, valuations are self-reported, and the incentive to avoid markdowns is embedded in the fee structure itself.
THE LIQUIDITY MISMATCH
The deeper problem, then, is not the defaults. It is the structure of the vehicles holding the loans.
Over the past several years, private credit managers have aggressively expanded into retail distribution, building what are known as semi-liquid vehicles — non-traded BDCs, interval funds, and similar structures that promise quarterly redemption windows to investors who are, in effect, holding loans with three-to-seven-year maturities. By mid-2025, $640 billion was held in evergreen vehicles, the vast majority in private wealth-focused structures. The five largest non-traded BDCs alone (Apollo, Ares, Blackstone, Carlyle, and KKR) manage more than $200 billion, up from zero in 2021.
The logic was that natural portfolio turnover — loans maturing, interest income, new capital inflows — would provide sufficient liquidity to meet redemption requests under normal conditions. The 5% quarterly cap on redemptions was presented as a feature, not a bug: it would prevent the kind of run dynamic that devastated open-ended property funds during prior stress events.
What the structure cannot survive is a simultaneous deterioration in asset quality and a spike in redemption requests. In Q4 2025, redemptions for non-traded BDCs tracked by Fitch rose to an average of 4.5% of net asset value — from 1.6% in just the prior quarter — pressing hard against that 5% cap. By Q1 of this year, the dam broke across the industry simultaneously.
The details here are instructive, because they illustrate how quickly sentiment can shift in a market with no daily pricing mechanism to absorb it more gradually. Blue Owl restructured withdrawal terms for its retail flagship fund on February 18, effectively converting it to a drawdown vehicle returning capital at a time not of shareholders’ choosing. BlackRock’s $26 billion HPS Corporate Lending Fund capped repurchases at 5% in early March after investors requested 9.3% of shares. Cliffwater’s $33 billion flagship limited redemptions to 7% after investors sought to pull a record 14%. Morgan Stanley’s North Haven Private Income Fund returned $169 million of $369 million requested. And as of March 23 — just two day ago as of the time of this writing — Apollo’s Debt Solutions BDC gated requests at 5%, returning roughly 45 cents on every dollar investors sought to withdraw after receiving redemption requests equal to 11.2% of shares outstanding.
Blackstone’s was the notable exception. Faced with $3.8 billion in withdrawal requests — a record 7.9% of its flagship BCRED fund — the firm and its executives injected $400 million of their own capital, lowering net requests to 7% and honoring every withdrawal in full. It was an extraordinary act of institutional confidence (or institutional desperation, depending on how this plays out). Either way, it is not a model that can be replicated industry-wide.
“The primary issue,” as Kaush Amin, Head of Private Market Investments at U.S. Bank Asset Management, put it, “is a mismatch in terms between the underlying loans and the redemption features of many of these funds. If there is an event that leads to many investors requesting redemptions, these structures have difficulty fulfilling these requests from their natural sources of liquidity [emphasis mine].”
This is not a new problem. Every financial crisis of the past century has involved some version of the same mismatch: illiquid assets funded by capital that can leave faster than the assets can be liquidated. The Savings & Loan crisis in the 1980s. Money market funds in 2008 (and the entire GFC, really). The open-ended property funds of 2016 and 2020. The mechanism varies; the danger of a rush for the exits, however, does not.
THE HISTORICAL ECHO
Private credit’s intellectual lineage runs directly to Michael Milken and the junk bond market of the 1980s. As Bloomberg has documented, private credit is “a new label on an old wine” — the newest phase of the leveraged debt revolution that Drexel Burnham Lambert started, spread to syndicated loans in the 1990s, and has now moved into direct lending. The players are different; the underlying dynamic is the same.
The junk bond market of the late 1980s collapsed not because the concept was wrong — there are legitimate borrowers who need capital and are willing to pay a premium for it — but because rapid growth attracted capital that wasn’t patient, lowered underwriting standards as competition intensified, and created a class of instruments that looked stable until they weren’t. From 1986 to 1995, a full third of U.S. savings and loan associations failed. The cascade was not driven by the initial defaults alone; it was driven by the discovery that the structures holding the assets were fragile.
The private credit market of 2026 is not the junk bond market of 1989. It is larger, more institutionalized, and more deeply embedded in the broader financial system. This is precisely what makes the structural risks worth taking seriously.
Jamie Dimon, JPMorgan’s CEO, warned in October 2025: “When you see one cockroach, there are probably more.” And bond investor Jeffrey Gundlach accused private lenders of making “garbage loans” and predicted the next financial crisis would originate in private credit. These may prove to be wrong (and quite possibly biased), but the fact that two of the most prominent voices in fixed income are raising these alarms publicly is itself a signal worth noting.
WHAT THIS MEANS FOR ALLOCATORS
For the sophisticated allocator, the private credit situation is not a reason to panic — it is a reason to think carefully about what, exactly, has been purchased and on what terms.
The asset class as a whole is not (yet) failing. Direct lending to well-underwritten middle-market borrowers, held in a closed-end structure with genuinely patient capital, can continue to perform. The Federal Reserve has noted that private credit has historically generated 2–4 percentage points above syndicated leveraged loans — a premium that reflects genuine illiquidity risk. The problem is not the asset class; it is the structure of specific vehicles, and the conflation of “private credit” as a monolithic category.
Three questions every allocator should be asking of their private credit exposure right now:
First: What is the PIK percentage of the portfolio? If a manager cannot answer this question quickly and precisely, that is itself informative. Rising PIK is the leading indicator of stress; it precedes both non-accruals and outright defaults, sometimes by years.
Second: What are the actual liquidity terms of the vehicle, and what happens when redemption requests exceed the cap? The events of late 2025 and early 2026 have shown that “semi-liquid” is a marketing description, not a structural guarantee. Understanding exactly how the queue works (and where you fall in it), how assets are sold to meet redemptions, and who bears the cost of that process matters enormously in a stress scenario.
Third: What is the concentration of software and technology borrowers? FSK’s largest single loan category is software and related services at 16.4% of exposure — and Moody’s, even at this level, flagged this as a key risk factor in its downgrade. But that figure could be low: Apollo’s CEO has noted his fund carries 20–30% less software exposure than peers, implying many portfolios carry software concentrations that are higher than the mid-teens. This is not hypothetical; it is already driving markdowns in specific portfolios.
The broader implication is structural, not cyclical. Private credit’s rise was funded, at least in part, by the same banks it was supposed to displace: JPMorgan’s lending to nonbank financial firms, a category that includes private credit vehicles, tripled to roughly $160 billion in 2025 from $50 billion in 2018. Of course, as we know from history (just as they did prior to the GFC) banks will continue to finance a sector or product category that they’re profiting from right up until the music stops. Risk has migrated outside the traditional banking perimeter — but it has not disappeared. When private credit funds need to liquidate assets quickly, they sell into a secondary market that is, as one industry participant noted, simply not large enough to absorb a systemic wave of redemptions.
The Federal Reserve and SEC are watching. The Financial Stability Oversight Council identified private credit interconnectedness as a financial stability concern in its 2024 annual report. This is a market where opacity has been a feature, not a bug — but regulators have begun to ask what the drains look like when the water is running out.
The question for every allocator who has positioned private credit as a low-volatility, high-yield alternative to public fixed income is whether the low volatility was real or simply a product of the fact that the assets price infrequently – and what happens if there is, indeed, a rush for the exits?
THE INVESTOR’S RESPONSIBILITY (YET AGAIN)
The temptation, in a credit stress environment, is often to repeat the explanations that exonerate the asset class: “these are idiosyncratic failures,” “the headline default rate is still low,” “the managers we’re invested with are different.” These responses may be correct in any individual case. They are also the exact responses that institutional allocators gave in 2006-07 about their structured credit exposure.
As I have said before, it is the responsibility of professional investors and stewards of capital to remain steadfast students of history and its cyclical nature. Every credit cycle ends the same way: a period of easy conditions attracts more capital than the market can absorb at the original underwriting standards; standards loosen; the next downturn reveals the gap between the stated risk and the actual risk. What differs cycle to cycle is the vehicle — junk bonds, CDOs, leveraged loans, and now private credit direct lending, increasingly held in “semi-liquid” retail wrappers.
The private credit market is not broken. But it is being repriced, in real time, against a set of assumptions that were formed in an era of near-zero interest rates, abundant liquidity, and a borrower universe that had not yet encountered generative AI. The allocators who navigate this well will be those who distinguished between the asset class and the structure — between real illiquidity premium and the illusion of stability that infrequent pricing can create.
The question is not whether private credit can have a role in a well-constructed portfolio (it does if it meets the investor’s objectives or the manager’s mandate). The question is whether the role it has been assigned and claims to fill — low-volatility, semi-liquid, yield-enhancing, accessible to retail investors — is the role it can actually play when the cycle turns.
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Footnotes:
- Payment-in-Kind (PIK) debt: A PIK loan allows the borrower to add interest owed to the principal balance rather than pay it in cash. The interest “compounds” into the principal, meaning the borrower owes more at maturity but preserves cash in the near term. PIK features became widespread during the leveraged buyout boom of the mid-2000s — in 2007, roughly 20% of buyout firms had issued PIK debt, and PIK accounted for 14% of total high-yield bond supply. After the 2008 crisis, PIK usage was associated with deep distress and fell sharply, so its resurgence is notable. BDCs are required by law to pay out at least 90% of their income as dividends, creating a particular tension when a growing portion of that income is non-cash.
- Business Development Companies (BDCs): BDCs are a form of closed-end investment fund regulated under the Investment Company Act of 1940. They are required to invest at least 70% of their assets in private U.S. companies and to distribute at least 90% of taxable income to shareholders. Non-traded BDCs — which do not list on a public exchange — have grown from zero in 2021 to more than $200 billion in assets by mid-2025, primarily through private wealth distribution channels. Their quarterly redemption caps (typically 5% of NAV per quarter, 20% annually) were designed to provide liquidity to retail investors while holding fundamentally illiquid assets. The tension between these two objectives is now the central issue in the private credit liquidity debate.