Investors exit private credit

After more than a decade of uninterrupted growth, the private credit market is facing its first major contraction. Recent weeks have seen a rush to exit the asset class, prompting several fund managers to “gate” redemptions – a move only likely to further erode investor confidence.

The primary catalyst for this slump is exposure to sectors threatened by agentic AI, specifically software companies. This secular shift is being compounded by macroeconomic volatility from the Middle East conflict and the reality of structurally higher interest rate.

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Post-GFC private credit boom

The aftermath of the Global Financial Crisis (GFC) of 2007–08 provided the backdrop enabling private credit to grow into a USD 2 trillion asset class. Quantitative easing and ultra-low yields forced investors to seek higher-yielding alternatives, while extreme volatility in public bond markets made private debt’s perceived stability more attractive.

Quantitative easing (QE) and the resulting ultra-low yields forced investors to seek higher-yielding alternatives, while extreme volatility in public bond markets made private debt’s perceived stability more attractive.

Simultaneously, traditional bank lending to corporates dried up. Post-GFC risk aversion and stricter regulatory requirements – such as capital and liquidity ratios for global systemically important banks (G-SIBs) – rendered unsecured interbank lending unaffordable. This forced large institutional borrowers to seek the alternative sources that now define the private credit landscape.

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Retail vulnerability and PE fallout

A major factor behind market nervousness has been the growth of retail investors attracted to the “illiquidity premium” that comes with private debt. Those same investors are now getting wise to the risk that comes with that premium, just as the US administration has ruled to allow 401 (K) retirement savings accounts to invest in private assets.

Further exacerbating the crisis is fallout from the private equity market. Much of the private credit market is generated from leveraged private equity deals. As many of these deals prove overvalued and difficult to exit in an environment of economic and interest rate uncertainty, the underlying financing is coming under extreme pressure.

Sources of leverage

Concerns over underwriting quality have resulted in many private debt funds – particularly business development companies (BDCs) – trading at a discount to net asset value (NAV). This distress is driven by three primary sources of leverage:

• Target company debt: Often substantial debt taken to fund acquisitions and amplify investment returns.
• Fund-level debt: BDCs can incur debt up to twice their net assets, significantly higher than the limits for traditional US mutual funds.
• Subscription credit lines (SCLs): Loans collateralized by “dry powder” (committed but undisbursed investor capital). While SCLs provide flexibility, they add a layer of systemic complexity during liquidity crunches.

Opportunity vs. systemic risk

Some distressed debt funds see the current private equity/private credit woes as opportunity – with one manager calling it “the biggest opportunity since 2008” – citing anecdotal evidence of forced selling, borrowers opting to defer repayments and increase loan balances, and low interest coverage ratios. But skeptics argue those firms are “talking their books”, incentivized to undermine market confidence.

Meanwhile, the specter of systemic risk looms, as concerns over the private credit have reignited wider worries over the shadow banking sector and its potential to destabilize financial markets, with talk of “gating” doing little to assuage investors’ fears.

While defenders argue that private credit leverage remains well below 2008 banking levels and benefits from higher recovery rates, the interconnectedness of banks and non-bank financial intermediaries (NBFIs) via loans, derivatives, and funding dependencies remains a potential source of global destabilization.

Read more on NBFIs and regulatory focus: NBFIs come under regulators’ spotlight

Intuition Know-How has a number of tutorials relevant to the content of this article:

• Alternative Assets – An Introduction
• Private Debt
• Private Equity – An Introduction
• Private Equity – Investing
• Shadow Banking & NFBIs
• Monetary Policy
• Regulation – An Introduction
• Banking Regulation – An Introduction
• Markets Regulation – An Introduction