Private credit's latest golden moment conceals market cracks

Anyone betting on the end of the private credit boom has been on the back foot of late as the upstart $1.6 trillion asset class has notched up a string of wins. But the industry’s naysayers won’t be conceding defeat just yet.

First up was Apollo Global Management Inc.’s credit business lifting management fees by almost a quarter in the first three months of 2025, then fellow titan Ares Management Corp. said it had pulled in $20 billion more client money. Talk of a golden opportunity for direct lenders has been revived as borrrowers seek safer shores amid the chaos of Donald Trump’s trade policies.

The fanbase is growing. In a new survey, consultants at Mercer Ltd. found half of large asset owners expect to expand their private credit portfolios in the next year, an 11% jump. Even as private equity has stumbled, investors — known as limited partners, or LPs — want to plow more money into its sister industry.

“Market prognosticators love to predict the pending doom,” says John Cocke, deputy chief investment officer at Corbin Capital Partners. “But in reality they’re ‘waiting for Godot’ as private credit is the only illiquid asset class that has produced systematic DPI for investors,” a key measure of returns that shows how much cash is generated relative to what’s been invested.

And yet, the investor giddiness isn’t always matched by what’s happening on the ground. Many companies backed by private capital, whether equity or credit, have been through the wringer as interest rates have stayed stubbornly high, and Trump-induced fears about the global economy won’t be helping.

Almost half of borrowers from direct lenders had negative free operating cashflow even before the US president’s “liberation day” tariff bombshell, the International Monetary Fund warned last month. That’s keeping many of them hooked on so-called payment in kind notes, it said, where businesses put off interest payments until later at often punishing rates.

Other warning signs come from people reworking the debt of ailing companies.

“Around 80% of the restructuring situations that we currently see involve private credit,” says Jat Bains, who leads the restructuring and insolvency group at law firm Macfarlanes. George Mills, a partner in EY-Parthenon’s turnaround and restructuring team, adds that “nearly all” of the complex restructuring situations his firm sees now include private credit funds.

The nature of direct lending, which usually involves just one or a handful of funds, does make it simpler for them to refinance problem companies, according to market participants. They tend to have more flexibility than investment banks, and it’s easier for them to take control of borrowers.

“You’re often dealing directly with the deal teams that put the loan in place, so they’re close to and knowledgeable about the situation,” says David Morris, head of UK restructuring and chief operating officer of EMEA corporate finance at FTI Consulting. “When private credit will reach out is when they don’t have good access or confidence in the financial information.”

Another reason for anxiety is that direct lenders still operate in the wider universe of riskier midsized companies, where fierce competition between debt providers often forces them to swallow lax legal terms on loans.

“There’s been a feeding frenzy on private credit, and it’s because it works well on paper,” says Ben Ashby, CIO at investment manager Henderson Rowe Ltd. “The projected returns look great,” he adds. “But at the end of the day, you’re taking some of the riskiest assets out there and leveraging them up as the investor protections, such as covenants, have worsened.”

Steady Eddies?

For investors, one of the chief regulatory concerns about private credit — how hard it is to sell the loans in a pinch — is also one of its greatest attractions. The promise of a supposedly stable asset class in a tumultuous world is a source of comfort to the pension funds and insurers who are staking the industry, outweighing fears about a lack of transparency on loan prices.

“We’ve not seen US LPs change their thoughts,” says Vijay Padmanabhan, a managing director at investment firm Cambridge Associates. “European LPs and some of the Asian LPs want to consider more local exposure, but they’ve not changed their views on private credit.”

So far this year, direct-lending funds have been almost boringly steady when set alongside the equity market’s wild rollercoaster ride — so long as you ignore the industry’s reluctance to change where it “marks” investments.

“The luck of timing,” has helped, according to Adam Grimsley, a private credit consultant for investors. “Liberation day” happened on 2 April, 24 hours after most firms produce quarterly valuations for investors. Many fund managers won’t have to update their marks until 1 July, by which time much of the tariff-related volatility may have blown over. Trump permitting.

Investors speaking to Bloomberg on condition of anonymity say they haven’t yet had communications from their private credit managers about altering valuations and they don’t expect large falls.

“There’s been a little bit of price pressure, but it’s very small,” says Matthew Pallai, CIO at Nomura Capital Management.

Any correction to values might also offer an opening for private capital’s bigger beasts to go bargain hunting, hence the comment from Ares Chief Executive Officer Mike Arougheti to Bloomberg TV last week about a possible “golden opportunity” to “deploy larger and larger dollars.” Oaktree Capital Management’s co-CEO Robert O’Leary also sees more chances to buy marked-down assets in the future.

However, many private credit firms have been investing for more than five years and have several maturing funds. While they’re out hunting for underpriced jewels, they’ll also need to keep an eye on their own portfolios. Last week, Fitch switched the outlook for a listed Oaktree direct-lending vehicle to negative, citing a meaningful deterioration in asset quality.

“Some LPs are asking more questions about valuations and actual true realizable value,” according to Grimsley, the consultant. “I think that’s still more of a PE story, but it will filter through.”

Exposed Corners

Private credit’s defenders point to the quality of its debt, much of which now consists of first-lien loans, and a drop in the average loan-to-value on typical deals to about 40%-50%. The market leaders also tend to diversify their portfolios across a large number of loans, industries and geographies, a possible buffer against economic stress.

For those lower down the food chain, the prognosis is less cheerful.

The real areas of worry are “portfolios heavily concentrated in second-lien loans, last-out positions within unitranche structures, or unsecured debt,” says Khang Nguyen, chief credit officer at Heron Finance. Even among first-lien-focused portfolios, experience matters, he adds. “Notably, around 90% of today’s private credit managers were launched post-GFC, many having operated only in a low-rate, growth-oriented market.”

Nguyen expects credit losses to remain minimal, even if recession hits. But there would be losers. A Heron team analyzed data from the financial crisis between Q3 2008 and Q1 2009 and found first-lien-focused private credit portfolios were down about 3% on average. Those concentrated in junior debt suffered declines of roughly 20%, in line with public markets.

An added complication this time around is that holders of first-lien loans are often taking heavy losses, too, as seen in the recent stampede of restructuring by private equity-owned companies.

Rivals Return

In the immediate aftermath of Trump’s tariff shocker, private credit funds looked like they were sitting pretty as Wall Street’s leveraged-loan teams recoiled from risk and larger debt issuers scouted around for alternatives. His subsequent retreats and resulting market rallies mean investment bankers are opening up for business again, especially in Europe.

That extra rivalry will in turn maintain the pressure on the extra returns direct lenders can charge on their loans, a key selling point for investors. Apollo and Citigroup Inc., in one striking example, charged 4.5 percentage points above the benchmark for a private financing backing Boeing’s carveout of its navigation unit, Bloomberg News reported. That’s razor thin for this market.

And a perhaps more ominous sign came when Scott Bessent addressed the Milken Institute Global Conference in Los Angeles recently. The US Treasury Secretary lauded private credit as an “incredible” element of the capital markets, but added that its growth “tells me that the regulated banking system has been too tightly constrained.”

For private credit’s many bulls, the reemergence of a Wall Street unchained would be the most consequential reality check yet.