Private credit has grown from roughly $500 billion to over $3.5 trillion in global assets under management in approximately a decade, according to AIMA's Financing the Economy 2025 report. Capital has flowed in because the pitch is compelling: consistent income, reported low volatility, and insulation from public market swings.
The speed of that growth carries a question investors should examine carefully. Is the risk being fully understood, or do the very features that make private credit attractive obscure it?
IN BRIEF
Private credit's appeal — stable reported returns and low visible volatility — may mask risks that build gradually through covenant erosion, competitive lending pressure, and declining underwriting discipline. Because private credit does not reprice daily, deterioration in credit quality may not surface until losses arrive abruptly rather than gradually.
Why is cash a more expensive hedge than it appears?
The case for holding cash during uncertainty seems straightforward: preserve capital, reduce volatility, wait for clarity. But this framing treats risk as a single variable, the chance of loss. In practice, risk has two dimensions: the risk of losing capital and the risk of failing to grow it.
What do stable reported returns actually obscure?
Unlike public markets, private credit does not reprice daily. That creates a different perception of risk, not necessarily a different reality. Losses don't appear gradually. They surface later, and often more abruptly, than public market equivalents.
A portfolio showing 8% annual returns with minimal volatility for three consecutive years may be accumulating credit risk not yet recognized in the marks. When that risk surfaces through a borrower default, a covenant breach, or a broader credit cycle turning, the adjustment tends to be sudden.
As more capital has entered the space, competitive pressure has intensified. Deployment reached $592.8 billion in 2024, up 78% from the prior year. That surge in capital deployment has produced four predictable consequences:
1. Lending standards loosen. Borrower quality thresholds decline as managers compete for deal flow. Credits that would not have been approved three years ago are now funded at comparable terms.
2. Covenant protections weaken. Covenant-lite structures (loans with fewer borrower restrictions and reduced lender intervention rights) were once confined to the broadly syndicated loan market and the largest borrowers. They have since moved downstream into the middle market. For borrowers above $100 million in EBITDA (earnings before interest, taxes, depreciation, and amortization), maintenance covenants are increasingly negotiated away. This reduces the lender's ability to intervene early when a business deteriorates.
IMF research confirms the trend: covenant-lite loans now dominate new issuance across the leveraged lending market. In 2024, covenant-lite loans accounted for 85% of all leveraged loan defaults, up from 54% in 2023, as these weaker structures now dominate both the stock and the default population.
3. Underwriting discipline erodes. Risk is priced more aggressively to win mandates, narrowing the margin of safety between yield earned and loss absorbed when a borrower defaults.
4. Deal structures shift toward borrowers. Terms increasingly favor the borrower, limiting lender recourse, expanding payment-in-kind (PIK) provisions, and reducing the structural protections that historically gave private credit its risk-adjusted return premium. By mid-2024, roughly 10% of interest income reported by business development companies came from PIK rather than cash. That suggests borrowers are deferring obligations rather than servicing them.
These shifts are subtle in isolation. Cumulatively, they may significantly change the risk profile of a private credit portfolio, often without any visible change in near-term reported returns.
Default rate data underscores the building pressure. Moody's estimates the private credit default rate in 2025 ranged between 1.6% and 4.7%, depending on whether distressed exchanges are included. Fitch's privately monitored ratings portfolio showed a higher figure: 9.2% for 2025, up from 8.1% in 2024, with smaller issuers driving the increase. The wide variation across methodologies itself signals a measurement challenge. Reported stability may understate actual credit deterioration.
We evaluate private credit risk through
the lens of decision-making quality,
incentive alignment, and leadership behavior
We assess the judgment calls that determine whether capital is protected or exposed before performance data reveals the answer. If you're assessing how private credit fits into your portfolio, or want a second perspective on manager discipline and deal structure, we're always open to a thoughtful conversation.
Schedule a Confidential DiscussionCash eliminates the first and guarantees the second.
JPMorgan Asset Management's Guide to the Markets, one of the most widely referenced datasets in institutional investing, tracks what happens to a hypothetical $10,000 investment in the S&P 500 depending on whether the investor stays fully invested or misses the strongest recovery days. Their data shows that $10,000 invested in 2005 would have grown to approximately $71,750 by the end of 2024 if the investor stayed fully invested. Missing just the 10 best trading days over that period would have cut the ending value to roughly $32,871. That is a 54% reduction in total accumulated wealth from missing fewer than 0.2% of trading days. Missing the best 60 days would have left the investor with less than the original $10,000.
Why has private credit become a core allocation?
The appeal is straightforward. Private credit has offered advantages difficult to find elsewhere in recent years.
Yield above public fixed income. With public bond yields compressed for much of the past decade, private credit offered a meaningful premium. T. Rowe Price research, which compares new-issue spreads between private direct lending and broadly syndicated loans from 2019 onward, found a persistent premium of 150 to 340 basis points (1.5% to 3.4%), compensating lenders for illiquidity and complexity.
Reported low volatility. Because private credit positions are not marked to market daily, reported return streams appear smoother than public equivalents. For investors whose boards or investment committees evaluate portfolio performance quarterly, that smoothness is attractive.
Structural protections. Historically, private credit transactions included maintenance covenants, lender-favorable terms, and meaningful recourse provisions. These gave lenders genuine influence over borrower behavior and early warning when businesses deteriorated.
Each of those advantages, however, rests on assumptions that deserve scrutiny.
Why does manager decision quality determine private credit outcomes?
Private credit is not a passive exposure. Outcomes depend on judgment calls made before capital is deployed: before a borrower is approved, before a structure is finalized, before a yield is locked in. This is where the asset class diverges most from public fixed income, and where the analytical lens matters most.
Four decisions typically shape results:
1. Deal structuring. Specifically, how protections, covenants, and recourse provisions are built into each transaction. A well-structured deal gives the lender influence when conditions change. A poorly structured deal leaves the lender exposed with limited ability to act.
2. Risk pricing. Whether the yield earned genuinely compensates for the risk taken. In a competitive lending environment, the temptation to accept thinner spreads to deploy capital is significant. The margin between adequate and inadequate compensation is narrower than it appears.
3. Borrower assessment. The quality and rigor of due diligence on the underlying business and, critically, on its leadership. A borrower's financial projections tell one story. The management team's track record of meeting projections and navigating revenue declines or margin compression tells another. The same CEO decision quality that drives public equity outcomes applies directly to private credit borrowers.
4. Manager discipline and incentive alignment. A manager's willingness to walk away from deals that don't meet their standards is typically the primary determinant of private credit outcomes. In a market where over $3.5 trillion in capital competes for deployment, the managers who consistently decline marginal credits will likely produce better risk-adjusted returns. Those who deploy aggressively to generate management fees usually will not.
Recovery rate data adds urgency to manager selection. Bloomberg research found that post-default recovery on direct loans averages roughly 33 cents on the dollar, compared to 52 cents for syndicated loans and 39 cents for high-yield bonds. The lower recovery means each default costs more in private credit. That makes the underwriting decisions that prevent defaults disproportionately valuable.
How can investors evaluate whether private credit discipline is intact?
The signals of deteriorating discipline are not always obvious, but they are observable. Four areas typically reveal changes before performance does.
1. Covenant strength across new issuance. Are lender protections tightening or loosening relative to the prior year? If covenant-lite terms are expanding into smaller and riskier borrower segments, competitive pressure is overriding discipline.
2. Deal structure trends. Are terms becoming more borrower-friendly than comparable deals from 12 to 18 months ago? Reduced recourse, expanded PIK provisions, and looser default triggers all suggest that capital deployment pressure is shaping terms more than credit judgment.
3. Yield relative to risk. Are reported yields rising without a corresponding increase in credit quality or structural protection? Unusually high returns in a tightening environment may reflect risk being underpriced rather than alpha being generated.
4. Manager behavior when deployment targets conflict with credit standards. Is the manager maintaining underwriting standards, or accepting weaker credits to meet deployment targets and earn management fees? When deployment pace accelerates while pipeline credit quality has not improved, the most likely explanation is that standards have quietly lowered.
Private credit is not a passive exposure. Outcomes depend on judgment calls made before capital is deployed.
Before a borrower is approved. Before a structure is finalized. Before a yield is locked in. This is where the asset class diverges most from public fixed income, and where the analytical lens matters most.
Eagle Talon Partners evaluates private credit risk through the lens of decision-making quality, incentive alignment, and leadership behavior.
Schedule a Confidential Discussion →What should investors be asking about their private credit allocation?
Private credit plays an important and legitimate role in a well-constructed portfolio. The question for family offices, endowments, and foundations evaluating private credit allocations is whether the underlying discipline that made it attractive remains intact. And whether the manager overseeing the allocation will maintain that discipline as competitive pressure builds.
In an asset class that has grown sevenfold in roughly a decade, the discipline question is more important than the yield on the next deal.
For investors who also hold public equities, the analytical lens is the same. Decision quality and capital allocation discipline, whether applied by a CEO deploying corporate capital or a private credit manager deploying investor capital, are the primary drivers of long-term outcomes. Protecting capital without holding cash requires the same structural discipline in private credit that it does in public markets.
What behavioral patterns typically undermine capital protection efforts?
Understanding these tools is necessary. Applying them when markets are falling sharply is harder. Three behavioral patterns tend to undermine capital protection, and each carries a hidden cost:
