Private credit continues to win market share among borrower companies underserved by traditional banks. To investors, the asset class may also provides a compelling combination of attractive potential income, portfolio diversification, and downside protection through covenants and structural seniority. However, investors must navigate tradeoffs, including limited liquidity, sensitivity to credit cycles and, importantly, variability in underwriting quality.

As headwinds rise and economic fog persists, investor concerns around private credit are growing. We believe the asset class will continue to offer strong risk-reward dynamics, particularly for investors who partner with disciplined and experienced managers.

DEFAULTS SPOTLIGHT UNDERWRITING DISCIPLINE

A series of high-profile bankruptcies recently affected a small segment of private credit lenders. However, lender exposure relative to overall private credit portfolios appears to be limited, and market fundamentals remain stable.

These defaults seem to be isolated incidents rather than signs of systemic weakness. The presence of alleged fraud and accounting irregularities suggests these cases stem from individual misconduct rather than worsening economic conditions or declining credit quality.

That said, these events have heightened the market’s attention on underwriting standards and transparency. For investors, this underscores the importance of working with managers who prioritise rigorous due diligence, focus on loan documentation and terms, and maintain a disciplined investment approach. Such practices  remain the most reliable safeguard for private credit investors.

COVENANTS: THE FIRST LINE OF DEFENSE

Fierce financing competition has driven convergence with the broadly syndicated loan (BSL) market, evidenced by a notable rise in covenant-lite structures across BSLs. In scenarios where traditional quarterly maintenance covenants are reduced or removed, the weakening of terms eliminates critical early warning signs and strips lenders of the ability to proactively address borrower distress before it escalates. This shift increases downside risk for investors by removing a key risk mitigation tool.

THE VANISHING SAFEGUARD: COVENANT EROSION IN THE BSL MARKET

THE CONSERVATIVE EDGE

Conservative loan structures with lower entry leverage and higher fixed charge ratios are built to withstand market and cash flow volatility. A lower initial loan-to-value ratio also provides a substantial equity cushion beneath the debt. This buffer absorbs valuation declines during cyclical downturns or periods of sponsor underperformance, significantly improving recovery prospects and reducing potential loss severity for the lender. Eliminating features like payment-in-kind (PIK) at origination further reinforces discipline. Requiring all-cash interest payments ensures lenders the borrower’s true cash earnings are transparent and prevent the compounding of debt, which can erode coverage ratios and accelerate distress.

DISCIPLINED MANAGERS WIN BY NOT LOSING

Amid broad concerns about private credit, seasoned managers are expected to stand out by maintaining disciplined underwriting practices. A conservative approach, emphasising strong covenants, prudent loan-to-value, leverage and fixed charge ratios, and limited PIK exposure at underwriting— combined with diversification across stable industries and regions—is critical for mitigating risks. These strategies are essential for navigating market uncertainties and preserving value through 2026 and beyond.