Understanding Recent Developments in Private Credit

Private credit has become a popular allocation in many diversified portfolios, offering income potential and access to opportunities traditionally available only to institutional investors. Within private credit, recent market headlines have placed direct lending—a strategy that provides loans to private companies—under the spotlight. Pointed questions have been raised around liquidity, solvency, valuations, redemptions, and how these investment vehicles function.

This overview is intended to provide context on the private credit direct lending market and insight into what may be driving today's headlines.

Private credit investments are designed to be long-term allocations within a portfolio. They can potentially enhance a portfolio's yield—since private credit may offer higher yields than public fixed income—and may provide additional diversification to a public fixed income portfolio. Investors should keep in mind key risks to this asset class, however, including limited transparency, illiquidity, and default risk, which can be amplified during periods of economic stress.

Direct lending is a key subset of the private credit asset class that makes private—generally floating-rate—loans directly to companies outside of public fixed income markets. While these floating rate loans can potentially provide protection against rising short-term interest rates for investors, they can also increase borrower stress and default risk.

Investors should consider that unlike publicly traded debt, direct lending investment vehicles, such as non-traded Business Development Companies (BDCs) and interval funds, do not offer daily liquidity and are generally not suitable for capital that could be needed on short notice.

Non-traded BDCs may offer periodic, limited liquidity—often 5% quarterly—but this is not guaranteed. Interval funds typically provide scheduled, limited liquidity, usually at the same 5% quarterly rate (subject to fund terms and extraordinary circumstances). Whether to seek liquidity from private credit at any given time depends on an investor's individual circumstances, risk tolerance, time horizon, and broader portfolio construction.

Recent headlines across direct lending reflect a convergence of macroeconomic, structural, and sentiment‑driven pressures. Higher interest rates and tighter financial conditions have increased stress on leveraged borrowers, especially borrowers who were issued loans when rates were at very low levels, prompting investors to reassess portfolio solvency. Funds with more loans originated during the low-rate era (prior to 2022) likely hold more stressed assets than newer funds with loans primarily issued after 2023.

There have also been some high-profile borrower defaults that have sparked headlines in the mainstream financial media. Meanwhile, sharp markdowns of individual loans over a relatively short period of time, and significant discrepancies in how firms value loans, have led to questions about the accuracy of direct lending loan pricing. At the same time, uncertainty around how AI advances may affect the long‑term earnings power of software and tech‑enabled businesses has added another layer of caution, particularly given direct lending's exposure to these industries. Together, these dynamics have intensified scrutiny of underwriting assumptions, forward cash‑flow forecasts, and private asset valuations.

Against this backdrop, redemption activity has picked up meaningfully, especially in semi‑liquid structures such as non‑traded BDCs and interval funds. In multiple cases, investor redemption requests have exceeded the typical 5% quarterly limit. Fund managers have responded with varying approaches: Some have strictly enforced contractual withdrawal caps and prorated withdrawals, others have temporarily increased repurchase offers, and still others have used asset sales, secondary transactions, or sponsor balance‑sheet support to provide additional liquidity. These differing responses highlight both the flexibility and the constraints of semi‑liquid private credit vehicles, as managers seek to balance investors' access to their capital with the need to avoid forced selling to protect both redeeming and remaining shareholders.

Overall, the recent headlines point less to a single fund‑specific issue and more to a broader reset of investor behavior—one driven by higher rates, greater liquidity awareness, and a closer examination of how private assets are priced and managed through a more volatile cycle.

At this stage, there are certainly pockets of stress in the direct lending market, particularly among older funds with a substantial percentage of loans that were originated when interest rates were very low. In addition, there are likely loans, especially stressed loans, that may not have been marked down sufficiently, or at all.

However, we currently view direct lending as having a reasonably large-scale liquidity issue rather than a systemic solvency issue, though conditions may evolve. Liquidity refers to when and how easily investors can access capital; solvency refers to whether the underlying assets are expected to repay. These are distinct concepts. In general, actions such as asset sales, pro-rata redemptions, or tender offers are best understood as liquidity management tools, and not necessarily indicators of borrower defaults or fund insolvency.

Pro-rata redemptions, for example, distribute available withdrawals proportionally based on an investor's ownership stake in a fund. If redemption requests exceed quarterly targets, an initial gating—or temporary, pre-negotiated withdrawal limit—consisting of these pro-rata redemptions could be used by funds to manage their liquidity. This is already occurring with some funds.

In a more extreme scenario, where redemption requests remain above the target (typically 5% quarterly) for an extended period and/or redemption requests spike to a much higher percentage, a suspension of redemptions, temporary or permanent, could be used by funds. Their goal is to avoid having to resort to sales of private loans, likely at substantial discounts, to fund redemptions.

We do not view a fund's use of pro-rata redemptions as a reason to redeem, assuming an investor can tolerate reduced liquidity and still believes in the quality of the fund's underlying loans. Whether to redeem from private credit depends on an investor's time horizon and liquidity needs. Investors should carefully monitor their liquidity situation and overall risk capacity and tolerance when deciding whether to keep their exposure or submit a redemption notice to a private credit fund.

Private credit, like many asset classes, can be affected by the broader economy. Our base case is that the economy had shown some signs of resilience and (in some sectors) reacceleration before the Iran war—aided by the continued AI infrastructure buildout and rebound in U.S. private payrolls. However, if persistently higher oil prices result in both a spending and labor shock, late-cycle dynamics can kick in, upping the odds of a recession. So far, companies have not resorted to layoffs, but we are watching to see if revenues come under pressure via consumers pulling back on spending given higher energy costs.

If the economy were to tip over into a recession, or if inflation were to pick up, forcing additional interest rate increases, this could evolve into a more systemic solvency issue since the resulting financial stress would likely cause more companies to default on their loan payments. It is important to remember that direct lending loans are generally made to smaller companies that usually have less financial cushion than their larger counterparts. If either of the above possibilities were to materialize, the financial outcome could be worse for direct lending than for public fixed income.

Periods of market stress may put pressure on the structures of semiliquid investments in private credit. While recent headlines have focused on gates, redemptions, and tender offers, these features are part of how private credit funds are designed to balance investor access with the long-term nature of their assets.

Understanding these mechanics—and separating liquidity timing from underlying credit performance—can help investors better evaluate developments as they arise.

For investors with questions about how direct lending or other private credit strategies may fit within their broader financial plan, discussions with a financial professional can help provide personalized context.