By Only when the tide goes out do you discover who’s been swimming naked. – Warren Buffett, Berkshire Hathaway 2001 Annual Letter
A recent string of defaults by companies at least partially funded by private credit has raised investor concerns that more bad news may be lurking in the space. First Brands Group, a maker of auto parts, filed for bankruptcy in September 2025 with approximately $10 billion in debt. In the same month, Tricolor Holdings, a subprime lender, also filed for bankruptcy, intending to dissolve the company. There are allegations that both borrowers engaged in some form of deception with lenders.
Then this year, BlackRock’s TCP Capital Corp. wrote down the value of a private loan to Infinite Commerce Holdings, an aggregator of online Amazon sellers, to zero from full value. There is also a fear that advances in artificial intelligence (AI) will impair lending to software companies and lead to more defaults.
The growing concerns have led to an increase in redemption requests from investors. While some managers have allowed the redemptions, a Blue Owl fund announced that it would stop quarterly redemptions until it can sell some assets. So what should investors think about private credit?
There’s a saying in the banking business that the worst of loans are made in the best of times. – Howard Marks, CNBC Market Movers, March 2026
The Rise Of Private Credit
What is private credit? Sources of credit within the US economy come from two sources: banks and capital markets. The capital markets’ source of funds is investors. Investors have a choice of public credit and private credit. Public credit is debt that typically has standardized disclosures, standardized settlement systems, daily trading, and mark-to-market pricing. Private credit can include customized terms, sometimes with an estimated value, and may require extensive due diligence and complex financing. Both the public and private credit markets include investment-grade and below-investment-grade lending, also known as high-yield or junk. For public and private credit, the majority of lending is in the investment-grade space, though most of the fears correctly relate to the below-investment-grade portion.
In the wake of the Global Financial Crisis, when the US and global banking systems came under intense stress, the US Congress passed the Dodd-Frank Act in 2010. Since the Dodd-Frank Act, a growing share of corporate credit has been extended to companies by entities outside the traditional US banking system than by those within. This trend has helped fuel the rise of private credit.
Recessions have become less common in modern times. Notably, there has only been one extremely brief recession during the pandemic since the rise of private credit. Just as happens in the banking system, more capital available for lending and increased competition inevitably lead to less desirable loans being made in private credit. This trend becomes more acute without the “cleansing” impact of a recession.
Risks
When you say private credit, it truly is private. There is no liquidity, no guarantees. – Howard Marks, XP Global Conference, March 2026
One reason given for the recent uptick in souring private credit loans is the rise in interest rates. Lending made during the ultra-low-interest-rate period from 2020 to 2021, immediately surrounding the pandemic, is no longer viable in the current interest-rate environment. Sharply rising interest rates pose a risk to highly indebted companies.
Using public high-yield bonds as an example, credit spreads, which are the compensation for the increased default risk of lending to anyone other than the US government, remain on the low end of their historical range. Notably, these credit spreads tend to increase sharply during economic downturns and periods of economic uncertainty.
Using portfolio data on Business Development Companies (BDCs), entities that typically provide private lending to middle-market companies, provides further insight into some risk factors.
Payment-in-Kind (PIK) bonds allow the borrower to pay interest by issuing additional debt rather than cash. Obviously, this increases risk as debt continues to mount and borrowers are more likely to choose this option when cash is scarce. Notably, Infinite Holdings was said to have a PIK-style debt structure.
As noted previously, the added new wrinkle in perceived credit risk is the threat of artificial intelligence (AI) to the software space. Software generally has attractive characteristics, as it is asset-light, can earn high margins, and can be sold on a subscription basis. However, if AI puts those attractive cash flow streams at risk, there are few to no assets to liquidate to repay the lender. At least in the BDC space, lending to the software industry is a significant portion of the portfolios.
Volatility
The low volatility of private equity is nothing but a mirage… It’s a mathematical fact that I resent. – Cliff Asness, Institutional Investor interview, June 2022
Using traditional measurements, the volatility of private credit is understated due to the lack of daily market pricing. This is not just an issue only for private credit but for any asset without daily market pricing. AQR’s Cliff Asness has written about the “volatility laudering” that comes from smoothed prices in private equity, but the concept is the same for private credit, though to a lesser extent.
Autocorrelation provides a mathematical measure of the smoothing of pricing coming from non-daily pricing. A positive autocorrelation tells you that you can predict future values using past values. Liquid markets with daily pricing typically exhibit very low or negative autocorrelation.
Using private equity as an example, a 2022 paper showed that smoothed returns yield an expected maximum drawdown of about 12%, while unsmoothed data indicate a downside on the order of 40%. Similarly, the smoothed data indicates a near-zero probability of a 30% drawdown over three years, whereas the reality is closer to 15%.
While the autocorrelation of private credit is not as high as that of private equity, the reported price volatility is understated relative to the unsmoothed reality of debt pricing. The smoothed volatility of returns from private credit is not bad in and of itself. Still, investors should not pay a premium for this lower volatility, which does not reflect economic reality.
Conclusions
The tide had never gone out on private credit (i.e., it hadn’t been tested). – Howard Marks, Cockroaches in the Coal Mine, Oaktree memo, November 2025
While most of this article focused on the risks of private credit, that is a function of any intelligent due diligence process that seeks to identify potential pitfalls and then assess the probability and severity of any occurrence relative to the upside opportunities. As with any investment, there are positive and negative aspects to private credit. There are debt defaults in public markets, so this credit-investing risk is not unique to private debt.
If investing in private credit now, it would be reasonable to assume that manager performance dispersion will be wider than in the past. This return dispersion would be a function of more capital in the space, leading to more competition, and of the lack of a significantly prolonged economic downturn to help investors sort managers’ credit-underwriting skills, given the growth of private credit beginning with the 2010 Dodd-Frank Act.
Given this expected dispersion in managers’ credit underwriting skills and returns, not to mention the significant differences in private credit exposures across managers and vehicles, investors should know what they own and the implications of wading into the space. While this is not a forecast of a recession, one will occur someday. This need for extensive due diligence is further underscored by the lack of an economic downturn, as defaults and credit stresses tend to rise during such periods. Furthermore, the rise in AI capabilities has ushered in new threats to some sectors, like software. Capitalism’s awesome power of ongoing creative destruction is not new, but it is always worth recalling as a risk when making projections about investment returns.
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