Private credit is a broad asset class that is roughly $40 trillion in size and encompasses non-bank lending and debt investments that are not publicly traded. Unlike bonds issued in public markets, private credit transactions are negotiated directly between borrowers and investors, resulting in bespoke structures tailored to the specific needs of each deal. The asset class spans several strategies, including mezzanine financing, real estate debt, distressed debt, and asset-backed lending — and while most of these categories are still in very solid positions, direct lending, which is a small piece of the private credit ecosystem, is the area that has recently been in the headlines.
At its core, direct lending involves non-bank lenders — typically alternative asset managers — providing senior secured loans directly to middle-market companies. These businesses are generally too large to rely solely on community banks yet too small to access broadly syndicated loan (BSL) markets efficiently. Direct lenders step into this gap, offering speed, certainty of execution, and flexible structures that traditional capital markets struggle to match.
The loans generated through direct lending are typically floating-rate instruments, tied to benchmarks such as SOFR (secured overnight financing rate), which generally become more attractive to investors as interest rates rise but more onerous to borrowers as interest expenses rise as well. They are also senior in the capital structure, meaning lenders hold the first claim on borrower assets in a default scenario. This combination of seniority, collateralization, and floating-rate income has made direct lending particularly attractive to institutional investors — pension funds, insurance companies, and endowments — seeking income with meaningful risk mitigation.
The Volcker Rule, part of the Dodd-Frank Act implemented after the 2008 financial crisis, prohibited large banks from engaging in proprietary trading and significantly restricted their ability to sponsor, invest in, or have certain relationships with private equity and hedge funds (as "covered funds"). This, combined with other post-crisis regulations like Basel III capital requirements, constrained banks' capacity and willingness to hold leveraged loans on their balance sheets or provide high-leverage financing to riskier borrowers, particularly in the middle market and for private equity-sponsored deals.
As such, growth in direct lending accelerated sharply following the 2008 Global Financial Crisis, as tightened bank regulation pushed lending appetite elsewhere. Alternative managers filled the void, and today the direct lending market represents nearly $2 trillion in deployed capital in the U.S. For middle-market borrowers, it offers a reliable funding partner. For investors, it delivers a yield premium over public credit — the so-called illiquidity premium — in exchange for capital lock-up (this is important).
Business Development Companies (BDCs) offer retail investors the most accessible entry point into private credit direct lending, providing high dividend yields due to their requirement to distribute 90% of taxable income. By investing mainly in the debt — and occasionally the equity — of middle‑market companies, they give individuals exposure to private credit strategies typically reserved for institutional investors. However, BDC portfolios can be opaque, often employ leverage, and experience net asset value (NAV) volatility unrelated to loan performance. Major players such as Ares Capital (ARCC), Blue Owl Capital (OWL), and FS KKR (FSK) now anchor an industry exceeding $500 billion in assets.
Meanwhile, private‑credit ETFs are emerging rapidly, though they face structural challenges since illiquid private loans must be housed within vehicles offering daily liquidity. As a result, most ETFs combine true private loans with syndicated or investment‑grade credit to manage redemptions and preserve liquidity. For investors, the appeal is higher yields with familiar ETF mechanics — but the exposure is only an approximation of private credit, and liquidity risks remain significant.
Private credit remains the area where structural risks are most deeply embedded — and least visible. Over the past five years, enterprise software has become a core theme for private credit and private equity, with direct lenders funding 40% – 70% of leveraged buyouts between 2022 and 2023, up sharply from 15–25% pre‑pandemic. Software and technology companies now represent over 20% of BDC investments, and market estimates are that between 25-35% of private‑credit portfolios carry some degree of AI‑related disruption risk.
Compounding this, many loans were underwritten with optimistic income growth expectations that are proving unrealistic in today’s higher-rate, slower‑growth environment. Borrowers face margin pressure, deteriorating interest coverage, and increased use of payment-in-kind (PIK) features — where borrowers accrue, rather than pay interest — while valuations have compressed and venture funding has cooled. With roughly 15% of SaaS borrowers struggling to cover interest expenses, the sector holds hundreds of billions of dollars that may be more susceptible to default than comparable public‑market credit.
That said, most loans are private equity-backed or sponsored. In this context, loan-to-value (LTV) ratios — which measure the loan amount relative to the enterprise value of the company — typically incorporate sizable equity cushions to protect lenders. Private credit loans often feature conservative LTVs in the range of 40–60% (frequently mid-40s to around 50–60%), meaning private equity sponsors contribute substantial equity (often 40–60% or more of the deal value). This creates a meaningful buffer that must be significantly eroded — through declines in company value, income drops, or other stresses — before the senior debt faces material impairment, enhancing risk mitigation compared to higher-leverage structures in some syndicated markets.
Growing unease about today’s private credit market has seemingly reached a crescendo, with comparisons to the mortgage excesses that fueled the run up to the Global Financial Crisis almost overshadowing the escalating conflict in Iran. Market commentators continue to warn that private credit’s surge, driven by nonbank firms stepping into roles once dominated by traditional lenders, echoes how subprime mortgage origination moved outside the banking system before 2008. In turn, this reduced market transparency and the overall health of financial markets. The recent bankruptcies of smaller private credit-backed portfolio companies and warnings from major market participants, most notably JPMorgan Chase CEO Jamie Dimon, have only fueled the already high levels of concern from investors.
The recent episode was triggered by a combination of AI/software disruption fears, broader market unease, and the realization that inflows could no longer absorb outflows in a declining-rate environment where retail investors reassessed liquidity and risk. Industry-wide redemption requests spiked in late 2025 and early 2026, with several other large non-traded BDCs and interval funds capping or slowing withdrawals. Sales volumes in some of the largest retail private credit vehicles have slowed markedly. Similar to a modern-day bank run, news stories highlighting increased withdrawal requests caused additional withdrawal requests, which were only amplified by the opaque nature of these strategies.
This liquidity crunch highlights a core tension: private credit may offer higher yields but holds long-dated, hard-to-sell assets. When redemptions hit critical mass, managers must either sell loans (often at a discount in stressed markets), gate (restrict) withdrawals, or restructure the vehicle — each option risking further investor outflows and reputational damage. The gating has already moderated retail inflows, sparked legal scrutiny over disclosure practices, and prompted debate about whether illiquid strategies belong in retail-accessible products.
While it is important to acknowledge the rise in credit risks, it is equally important to separate credit risk from systemic risk. For those of us that lived through the Global Financial Crisis, we see some similarities but distinct and important differences. What we are seeing today looks more like a healthy repricing and shift in sentiment — not the start of a broad credit unwind. Historically, systemic risk becomes a concern when corporate debt grows significantly faster than the overall economy. By that measure, we are not seeing red flags. Sub‑investment‑grade lending remains manageable relative to GDP, and even with the growth of private credit, the total share of non‑investment‑grade corporate lending is roughly where it was a decade ago. In fact, overall corporate debt‑to‑GDP levels have actually come down in recent years.
This protective design is common across the private credit ecosystem. Private‑credit collateralized loan obligations (CLOs), for example, have structural features that automatically redirect cash flows during periods of strain, limiting the need to sell assets. Insurance companies, another key investor group, are also insulated from forced selling thanks to surrender penalties, liquidity facilities, and allocations to more liquid bonds that can be tapped first. Taken together, these structural safeguards help ensure that forced selling is unlikely to become a meaningful source of systemic risk.
Investor Warren Buffett famously said, “When the tide goes out, you see who has been swimming naked.” And over the past few years, liquidity has been abundant, but that liquidity is now ebbing. Private markets enjoyed a powerful tailwind during the period of ultra‑low interest rates, and it is highly likely that many deals were underwritten with overly optimistic assumptions during that stretch. That suggests there is still likely additional adjustment and potential pain ahead. While concerns are warranted, this does not imply that the broader private‑market asset class is in jeopardy.
The era of ultra-low interest rates (post-GFC through much of the 2010s and early 2020s) played a key role in fueling current excesses in private credit by driving a relentless "search for yield." With traditional safe assets offering near-zero returns, institutional investors piled into higher-yielding alternatives like private credit, enabling looser underwriting, higher leverage in some deals, and rapid AUM growth. This contributed to competitive dynamics where capital chased deals, sometimes compressing spreads and accepting lower-quality borrowers — a classic late-cycle behavior. Yet this is part of the natural credit cycle: low rates inflate asset prices and encourage risk-taking, while rising rates (as seen recently) discipline the market, force selectivity, and reset valuations. Overall, while excesses built during the low-rate regime warrant caution (particularly as 2020 and 2021 vintages need to refinance into a higher interest rate environment), the asset class's investor protections will hopefully limit spillovers into the broader economy.
This material is for general information only and is not intended to provide specific advice or recommendations for any individual. There is no assurance that the views or strategies discussed are suitable for all investors or will yield positive outcomes. Investing involves risks including possible loss of principal. Any economic forecasts set forth may not develop as predicted and are subject to change.
Data provided by the Wall Street Journal, Financial Times, and LPL Financial, tracking#1081775.
US Treasuries may be considered “safe haven” investments but do carry some degree of risk including interest rate, credit, and market risk. Bonds are subject to market and interest rate risk if sold prior to maturity.
The Standard & Poor’s 500 Index (S&P500) is a capitalization-weighted index of 500 stocks designed to measure performance of the broad domestic economy through changes in the market value of the stocks representing major industries.
- International investing involves special risks such as currency fluctuation and political instability. These risks may be heightened for investments in emerging markets.