A Roadmap for Resilience
PGIM managers delve into key trends, offering valuable insights on navigating risks and unlocking potential in this challenging environment.
Conservatism Wins in Private Credit
Jun 18, 2025
PGIM Private Capital’s Matthew Harvey highlights how competition in larger markets is driving better opportunities and return potential in the middle market.
Growth has defined private credit since the 2008 financial crisis, attracting investors seeking steady returns, attractive spreads, and flexibility. Its resilience during equity market turbulence adds to its appeal, but investors should note a key risk: many newer private credit managers lack experience navigating today’s complex conditions.
While credit markets remain stable, challenges like trade, geopolitics, and inflation could create headwinds. However, these same factors may also present opportunities through higher base rates and wider credit spreads.
SELECTIVITY CRITICAL AS ECONOMY SLOWS
Be picky about PIK loans: Since 2022, rising interest rates have placed significant strain on heavily leveraged companies, with many now facing interest payments that exceed their cash flow. To address short term liquidity issues, payment-in-kind (PIK) loans have become a popular option. These loans let borrowers defer cash interest payments by adding unpaid interest to the loan’s principal, postponing immediate outflows.
The rise of PIK loans is fueled by intense competition in private credit markets, particularly in larger segments. However, these higher-interest loans carry greater credit and default risks, which can be an issue in a slowing economy as borrowers struggle to meet obligations. For interval funds and business development companies, managing PIK loans is challenging since unpaid interest must still be distributed to shareholders, adding pressure in uncertain times.
Seek stronger covenants: At the same time, slowing M&A and IPO activity, along with fears of “zombie” companies unable to restructure, adds to the challenges. Weaker covenants across the industry increase risks if the economy worsens. As growth slows, untested companies and newer private credit managers face mounting obstacles. Underperforming companies with covenant-lite structures prevent lenders from exerting influence before a borrower’s performance significantly deteriorates, which can negatively impact investor recoveries.
Amid intense lender competition, it will be crucial to assess manager risk appetite for PIK loans and covenant-lite structures that can subsequently jeopardise credit performance in distress scenarios.
MIDDLE MARKET RESILIENCY SHINES
While many lenders focus on the larger market segments, we see greater potential in middle-market companies. These businesses offer better risk-adjusted return potential, with higher yields and lower leverage. The middle market stands out as a sweet spot, benefiting from fewer PIK loans and stronger covenant protections.
NON-SPONSORED DEALS FILL THE SPONSORED GAP
Private credit volumes are largely driven by M&A activity backed by private equity sponsors. However, many private credit lenders, traditionally focused on sponsored deals, are facing challenges from elevated interest rates and tariff uncertainties. With a subdued M&A outlook, non-sponsored deals can be a compelling option for lenders to stay competitive and source new transactions as well as offer diversification to the typical leveraged buyout (LBO) cycle.
LOWER PIK AND MORE COVENANTS IN SMALLER MARKETS
Source: S&P Global Ratings as of April 2025.
"In private credit, avoiding losses is essential, especially in today’s volatile market. Success lies in working with experienced managers who prioritise conservative strategies, including disciplined loan-to-value ratios, strong covenants, and minimal reliance on risky PIK loans."
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