Private credit warning signs are emerging beneath the surface, says TD’s Uk-Sun Kim

As private credit continues its rapid expansion, particularly through semi-liquid fund structures, advisors are being urged to look beyond headline yields and dig deeper into underlying risks.

Private credit has grown rapidly in recent years, especially in semi-liquid structures. What are the most important warning signs advisors should be watching for today that might indicate rising stress beneath the surface?

Uk-Sun Kim, TD’s Head Of Credit Originations, Middle Market and Sponsor Finance, tells InvestmentNews that there are already signs that stress may be building beneath the surface.

“First, there’s opacity in valuation and marking, which can raise concerns, particularly given how some reported NAVs behaved during the prior rate hike cycle,” he explains, adding that, in addition, “PIK income is creeping up as a share of fund revenue, meaning borrowers are paying in additional debt rather than cash.”

He also highlights the importance of benchmarking against more transparent systems. “From a comparability standpoint, banks’ loss data is audited and stress-tested by regulators each quarter. Reported results can differ for ‘similar’ risk profiles, which is something worth digging into.”

We’re seeing more asset sales by private credit managers—how should retail investors interpret these moves? Are they a sign of prudent portfolio management or potential liquidity strain?

Context is everything

“The key question is whether the manager is selling because they want to or because their fund structure requires it,” Kim explains. “When asset sales coincide with redemption windows, that’s not portfolio optimization; that’s meeting outflows.”

That distinction matters because it can influence the quality of decisions being made.

“That dynamic can lead to selling whatever can be moved at an acceptable price,” Kim says, contrasting this with traditional lenders: “By contrast, banks can hold credits on balance sheet through full cycles.”

For advisors recommending private credit funds to clients, how should they think about liquidity risk versus yield in today’s higher-rate environment? Kim stresses that not all private credit funds are created equal, making due diligence essential.

“In today's environment, it’s critical to look very closely at the specific fund's assets and portfolio composition,” he says. He also warns that broad narratives can distort risk perception. “Contagion can also spread when the industry is painted with a broad brush, particularly around sectors like software and AI.”

Importantly, Kim cautions against taking yield at face value.

“Equating yield as actual return is challenging. The quoted yield assumes the borrower pays, the fund doesn’t need to fire-sell assets, and the investor can actually access capital when needed,” he explains, noting that ultimately, “assessing the true liquidity buffer in a downside environment is key to understanding the risk.”

Having highlighted differences between bank lending and private credit structures, what risks does Kim see that retail investors might overlook when accessing private credit through funds rather than direct lending relationships?

“Key considerations include covenants, workout capability, and valuation accountability,” he says. “Direct lending was supposed to be the covenant-protected alternative to BSL, but a lot of deals from the 2020–2022 boom loosened considerably.”

As the credit cycle matures, how should advisors reassess the role of private credit in a diversified portfolio? Does it still serve as a reliable income and diversification tool?

Overstated diversification benefits?

While private credit continues to deliver income, Kim cautions that its diversification benefits may be overstated.

 “The income component is real, but the low-correlation story is often overstated,” he says. “Much of that perceived diversification comes from infrequent marking rather than true economic diversification. It’s the same borrower facing the same macro pressures, regardless of whether a bank or a fund holds the loan.”

As a result, he suggests a more balanced approach: “Advisors should consider tilting toward first-lien senior secured exposure, reducing single-manager concentration, and pairing private credit with investment-grade fixed income to avoid a one-dimensional income stream.”

With counterparty risk becoming more relevant again, Kim says there are practical steps that advisors can take to evaluate the strength and discipline of private credit managers on behalf of their clients. Due diligence on managers is becoming increasingly important as conditions tighten.

“Two key things are important to evaluate: capital structure, specifically the balance between permanent capital and redemption-sensitive vehicles, and whether the manager is using back leverage,” he says.

Experience across cycles is another differentiator. “Cycle experience also matters, and asking for actual recovery data from past restructurings can provide a more complete picture.”

Looking ahead, does Kim expect a widening gap between top-tier private credit managers and weaker players? And how can advisors identify which managers are best positioned to navigate a more challenging credit environment?

“A gap is already beginning to form, though reported marks may lag that reality,” he says.

Rapid industry growth has masked differences in quality. “The market grew so fast that managers with thinner infrastructure and looser underwriting were able to raise capital and appear comparable to more seasoned platforms, particularly with low defaults that made everyone look similar.”

Going forward, distinguishing between managers will be critical.

Advisors, Kim says, should focus on “institutional scale and infrastructure, verifiable loss data across a full cycle, a conservative origination culture, and a capital base that doesn’t force suboptimal decisions under stress.”