Private credit has proven resilient in the face of inflation and interest rate headwinds, but after a prolonged period of macroeconomic disruption, pockets of pressure are creeping into portfolios
Despite a complex operating environment, persistent inflation and tariff-related economic disruption, private credit lending has remained robust, and portfolios have proven resilient.
At the end of October, trailing one-year private credit defaults in the US came in at just 2.15% by value and 2.83% by deal count, outperforming public syndicated loan markets, according to private markets manager Future Standard.
However, signs of stress have crept into corners of the market. Pressure on financial performance is building in certain sectors as a result of elevated interest rates and tariff pressures, and private credit is not immune to this broader trend.
Selective defaults
Some pandemic-era vintage loans are also coming under scrutiny. In a number of cases, private credit lenders have supported these borrowers by offering covenant holidays and/or payment-in-kind (PIK) interest flexibility to assist borrowers in navigating a period of macroeconomic uncertainty and elevated interest rates.
Research from S&P Global Intelligence suggests there has been a surge in “selective defaults” in private credit, which refer to covenant waivers, distressed debt exchanges and other out-of-court restructurings that can be considered tantamount to a default. According to S&P Global, these selective defaults outpaced conventional defaults five to one in 2024. This could point to elevated levels of stress that headline default figures do not immediately reveal.
There has also been an increase in the percentage of new loans issued with PIK flexibility from day one. Figures from investment bank Configure Partners show that the percentage of loans with a PIK feature included at issuance rose from 14.8% in Q2 2025 to 22.2% in Q3. Configure Partners attributes this increase to competitive structuring on the part of lenders to win deals rather than liquidity stress. But, higher amounts of PIK issuance, particularly when combined with “cov-lite” structures, which have become common in the private credit market, can make it more difficult to detect long-term credit stress by delaying the onset of defaults.
Addressing risks proactively
Private credit deals are typically executed bilaterally, or with small clubs of private credit providers. This means borrowers typically know exactly who their lenders are, which makes it easier for parties to come to the table and devise solutions to navigate through difficult periods in the credit cycle. In addition, many private credit capital structures consist of a single tranche of loans without any other debt of meaningful value on the company’s balance sheet. This makes it much easier to negotiate amendments and restructurings.
However, in syndicated loan markets, the lender base is often highly fragmented. Lender groups are more amorphous, with different investment strategies and return horizons. Due to the public trading of these loans, they are often held by a mix of CLOs and distressed funds.
Capital structures in syndicated loan contexts can also be much more complex, sometimes involving multiple creditor groups with different claims, lien priorities and terms. In those circumstances, Chapter 11 bankruptcy is sometimes seen as the most efficient route when trying to resolve competing creditor interests.
The smaller lender groups in private credit structures also make it less likely for stressed or distressed borrowers to enter into liability management exercises (LMEs), in which existing or new lenders can maneuver to put themselves in a superior position to other lenders within the same capital structure, while allowing the borrower to make changes to its existing capital structure to achieve their desired financial outcomes.
LMEs have become more commonplace in syndicated loan markets but remain a rarity in the private credit space. Some market participants have postulated that this is because private credit lenders are much more likely to know their counterparts in the capital structure and will have to factor in future long-term investment strategies, which will often be predicated on working amicably with their peers to finance future deals. The close relationships with other private credit firms are also replicated with private equity sponsors, who may be reticent to conduct an LME against a private credit lender who they are relying on to finance future deals.
Finally, many private credit firms have strengthened their internal portfolio management and workout teams in anticipation of workouts and restructurings, including by hiring dedicated workout professionals.
Document details
Another way private credit lenders can manage their downside exposure is by reviewing their debt documents to understand what may be possible in terms of LME maneuvers that a sponsor could attempt in a stressed or distressed situation.
Once a deal enters distress, a consensual solution is always the best possible outcome. Nevertheless, private credit firms should always have clarity on what could happen if a sponsor or borrower decides to adopt a less consensual approach to dealing with stress or distress.
Private credit players typically seek to incorporate a package of LME “blocker” terms in debt documentation at the outset of deals. However, as the range and structure of LMEs has evolved, so have the blocker provisions, and, in a competitive market, it is not always possible to include the best possible blocker provisions.
Another strategy we have seen from some direct lenders in the distressed context is to form so-called co-op agreements with their peers. While there are many different flavors of co-op agreements in the market, in their simplest form, a group of lenders that, in the aggregate, form a majority, typically agree to group together and only accept an LME transaction if all lenders in the co-op are offered the same terms. Co-op agreements allow lenders to increase their leverage against the sponsor and ensure that the members of the co-op agreement will not be excluded from any transaction that is agreed among any of the lenders to the co-op agreement. Given the ability of the lenders to improve their bargaining position, there has been pushback in the market on co-op agreements by borrowers, including a recent lawsuit challenging such an arrangement as an antitrust violation.
Today, the challenge for private credit players is to strike a balance between ensuring they can negotiate the required covenant protections and LME blockers and not risk the loss of a deal to a competitor who is willing to accept more flexible terms.
In a still unpredictable market with pockets of stress, private credit players will be working hard to secure the best possible terms, shore up existing portfolios and ensure that they have a large and flexible toolbox if default risk begins to escalate.
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