The story of private credit begins not with a brilliant innovation but with an absence. The 2008 financial crisis did not just destroy capital. It destroyed the regulatory appetite for the kind of lending that had sustained the middle market for decades.
Basel III, Dodd-Frank, and their international equivalents did precisely what they were designed to do. They made bank balance sheets safer. They also made them less useful to the segment of the economy that needed credit most: the mid-market borrower, the leveraged buyout, the growth company that did not qualify for the investment grade market but was too large for a regional bank line.
Banks retreated. They had to. The risk-weighted asset charges on leveraged loans, the liquidity coverage ratios, the stress testing requirements — all of it pushed the return on equity of middle-market lending below the hurdle rates that public bank shareholders would accept. The business was not prohibited. It was priced out.
Into that vacuum stepped private credit. The timing was perfect. Institutional investors — pension funds, insurance companies, sovereign wealth funds, endowments — were simultaneously desperate for yield in a zero-rate environment and uncomfortable with the volatility of public credit markets. Private credit offered something that looked almost too good: higher yields, low mark-to-market volatility, predictable income streams, and senior secured positioning in the capital structure.
The market that was approximately $500 billion in 2015 had grown to an estimated $1.7 trillion by 2024. By some projections it is on track for $2.5 trillion by 2027. Blackstone, Apollo, Ares, Blue Owl, and a dozen other managers built franchises of a scale that would have been unimaginable to the leveraged finance desks of the pre-crisis banks.
This growth was not irrational in its origins. The structural case for private credit as an asset class was genuine. Senior secured floating rate loans to profitable companies with real assets and real earnings streams are not inherently dangerous instruments. The danger, as always in credit, is not in the instrument. It is in the cycle, the underwriting standards, and the structure of the vehicles through which the capital is deployed.
II. The Architecture of the Boom
A typical private credit transaction involves a direct lender extending a floating rate term loan to a private equity-backed company at a spread of 500 to 700 basis points over SOFR. The loan is senior secured, with covenants, and sits at the top of the borrower's capital structure. In the 2022 to 2024 rate environment, all-in yields were running at 11 to 13 percent.
For the lender, this looks attractive. For the borrower, a private equity portfolio company carrying leverage of five to seven times EBITDA at a cost of 12 percent, the arithmetic is considerably more strained. Interest coverage ratios that were comfortable at 400 basis points SOFR became uncomfortable at 550 basis points.
In the private credit market, that stress does not show up visibly. The assets are not publicly traded. The marks are set by the manager. The quarterly valuation process involves considerable discretion, and the incentive structure of a manager who earns fees on the basis of NAV is not perfectly aligned with the incentive to mark assets accurately. The low volatility that makes private credit attractive to allocators is not entirely a reflection of the underlying credit quality. It is partly a reflection of the fact that the volatility is not being measured.
III. The Underwriting Drift
Every credit cycle has the same arc. It begins with disciplined underwriting on genuinely attractive credits. It ends with the same structures applied to progressively weaker credits at progressively tighter spreads, because the capital chasing the asset class has grown faster than the universe of suitable borrowers.
Private credit in 2024 shows clear signs of having entered the later stages of this arc. Covenant-lite structures have migrated into the direct lending market. PIK features, which allow borrowers to defer cash interest payments by adding to the loan principal, have become increasingly common. A borrower that cannot service its debt in cash but is being allowed to roll interest into principal is not a performing credit in any meaningful sense. It is a deferred problem.
The definition of EBITDA used to calculate leverage multiples has been stretched through addbacks — projected synergies, one-time adjustments, normalised earnings that have not yet materialised — to a degree that would have been considered aggressive even at the peak of the 2006 to 2007 leveraged finance cycle. Companies that were underwritten at two percent SOFR are now servicing debt at five percent SOFR. Equity sponsors have, in many cases, chosen to support portfolio companies with additional equity injections rather than allow defaults that would crystallise losses. This has delayed the recognition of stress. It has not eliminated it.
IV. The Liquidity Question
The most structurally important feature of private credit, and the one most relevant to what happens when the cycle turns, is the liquidity mismatch that exists in certain parts of the market. Direct lending funds structured as closed-end vehicles are reasonably well matched to the illiquidity of the underlying assets.
The problem lies with vehicles that have attempted to democratise access to private credit by offering periodic liquidity — quarterly or monthly redemptions — against a portfolio of inherently illiquid assets. Business Development Companies, non-traded REITs structured as credit vehicles, and certain interval funds have grown rapidly by offering retail and semi-institutional investors access to private credit yields with the promise of periodic exit.
The promise of periodic liquidity from an illiquid asset is the oldest structural mismatch in finance. It was the promise made by money market funds before 2008. It was the promise made by open-ended property funds before 2016 and again before 2020. In each case, the mismatch was manageable during periods of low redemption pressure and became unmanageable the moment investors decided they wanted their money back at the same time.
V. The Asia Lens
Japanese regional banks have built meaningful exposure to US private credit and CLO structures as part of their search for yield in a domestic zero-rate environment. A dislocation in US private credit would not show up immediately in their reported figures — the illiquidity of the assets creates the same marking delay as it does for US managers — but it would show up eventually, and the opacity of the exposure makes it harder to assess from the outside.
Indian NBFCs fill the same structural role that private credit fills in the US — extending credit to borrowers that the formal banking system underserves — and they carry some of the same structural vulnerabilities. The IL&FS crisis of 2018 and the DHFL collapse of 2019 were early-cycle demonstrations of what happens when confidence in a shadow credit system fractures.
Korean corporate credit, where chaebols and their affiliates carry leverage that is often obscured by the complexity of cross-shareholding structures, would face additional pressure in a global credit tightening. The private credit problem, if it becomes one, will not stay in New York and London. It will travel through the channels that institutional capital has built over the past decade.
The next piece in this series examines the BDC market specifically — the publicly traded window into private credit that is already showing, in its market prices, what the NAV marks are not yet reflecting.