Private Credit's Stress Is No Longer Hidden

 

Private Credit's Stress Is No Longer Hidden

## Introduction: The $2 Trillion Secret That's No Longer a Secret

There's a moment in every financial cycle when the hidden becomes visible. When the whispers become headlines. When the "private" in private credit stops meaning opaque and starts meaning *troubled*.

That moment is now.

For more than a decade, private credit has been the financial industry's best-kept secret. A $2 trillion market that grew in the shadows of traditional banking, fueled by ultra-low interest rates, post-2008 banking regulations, and yield-hungry investors. It was the asset class that promised superior returns with lower volatility — a financial unicorn that seemed too good to be true.

It was too good to be true.

On Monday, August 17, 2026, the Financial Times published a devastating analysis of the private credit industry. The data crunched by the FT shows that the value of troubled loans held by some of the biggest private debt investors has reached levels last seen in 2017, when the industry was dealing with a hangover from an oil price crash. Some of the largest funds are taking writedowns on their private credit portfolios and warning about problem loans. Non-accruals — loans that funds might not get repaid on or might lose money on — are rising to the highest levels in about a decade.

The stress is no longer hidden. The question is: **how bad is it going to get?**

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## The Scale of the Problem: A $2 Trillion Industry Under Pressure

### What Is Private Credit?

Private credit is exactly what it sounds like: loans made by non-bank lenders to companies that can't or won't borrow from traditional banks. It includes direct lending, mezzanine debt, distressed debt, and specialty finance. The borrowers are often middle-market companies — too big for a small business loan, too small for the public bond markets.

The industry grew from a niche into a $2 trillion force over the past decade. It financed software companies, healthcare rollups, and industrial firms. It was fueled by a perfect storm: ultra-low interest rates made borrowing cheap, post-2008 banking regulations pushed risky lending out of the banks, and yield-hungry investors chased higher returns.

### The Numbers That Matter Now

The data painting the picture of distress is stark:

- **Non-accrual rates** at the 20 largest publicly traded business development companies (BDCs) — listed funds that invest in private credit loans — climbed to a median **2.8%** of their cost in the second quarter, up from 2% at the end of March. That's the highest level since 2017.

- **Fitch Ratings** reported that the U.S. private credit default rate hit a record **6.0%** in April 2026. The rating agency estimated that private-credit-backed corporate borrowers experienced a **9.2%** default rate in 2025.

- **Fitch's July 2026 default rate** has climbed even higher, reaching **9.5%** in its U.S. private credit universe, up from 9.4% in June and 6.9% in July 2025.

- **Redemption requests** at non-traded BDCs tracked by Fitch reached an average **10.3%** of shares outstanding in the second quarter, up from 9.7% in the prior period and more than double the typical 5% quarterly repurchase limit.

- **KKR's listed fund**, FS KKR Capital Group, reported that **7.1%** of its loan book was troubled in the second quarter — far above the industry average.

- **Bank of America's credit strategy team** has called private credit "the lowest quality asset class across our leveraged finance universe".

### The Hidden Stress: Shadow Defaults and "Bad PIK"

The official default numbers may actually understate the true distress. Formal default rates are increasingly poor diagnostics for the health of private credit. More revealing signals include "shadow defaults" and "bad PIK".

Payment-in-kind (PIK) structures allow borrowers to pay interest with more debt rather than cash. It sounds like a lifeline. In reality, it's often a sign that a company can't generate enough cash to service its obligations. In 2025, shadow default rates were nearly three times their 2021 levels, a trend that has continued into 2026.

Moody's estimates that distressed restructurings — debt exchanges and maturity extensions agreed under duress — accounted for roughly **65% of all 2025 private credit defaults**. Excluding them produces headline rates of 1.6%–4.7%; including them reveals a materially worse picture.

As David Golub, co-chief executive of Golub Capital, told investors: **"We're in a credit cycle. Others denied it for a while. I don't think there's a lot of denial any more"**.

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## The Root Causes: Why Private Credit Is Breaking

### The Boom-Time Hangover

The loans that are now going bad were made years ago, during the boom times of 2020 and 2021. Private equity firms were scooping up companies, heaping loads of debt on to them, and much of that was financed by the private credit industry. Interest rates were near zero, and the stock market was trading at record highs.

Those deals were built on assumptions that no longer hold. Companies borrowed heavily at floating rates, assuming rates would stay low. They didn't.

### The Rate Shock

The yield on the 10-year U.S. Treasury note climbed above 4.68% in May 2026, and the 30-year note surpassed 5.19% — a level not seen since 2007. The yield spike is happening globally alongside the U.S.-Israel war on Iran, which has pushed up energy prices and inflation, spooking investors who want greater returns.

Private credit firms make money on interest rate spreads based on Treasury yields. When yields rise, their borrowing costs rise. When companies need to refinance, they face higher rates. And when they can't refinance, they default.

Westwood Capital managing partner Dan Alpert told CNBC that he had been "very worried" and that rising interest rates were only making matters worse. "Higher Treasury rates make it harder for companies to refinance, and you've got a jittery market out there worried about inflation," he said. **"Teasing [the macroeconomic factors] apart from what I believe is some significant credit weakness in private credit is very, very difficult"**.

### The Software Sector Exposure

One of the biggest vulnerabilities in private credit is its substantial exposure to the **software sector**, the biggest subsector of the IT industry. The rise of AI has triggered concerns that the technology could disrupt the business models of software firms. AI disruption has already started repricing software companies, which dominate private-lending portfolios.

### The Refinancing Wall

The most significant forward risk lies in the **refinancing wall**. More than **$620 billion in debt is approaching maturity between 2026 and 2028** — a staggering amount that will need to be refinanced at much higher rates than when the loans were originated. If companies can't refinance, they default. If they can refinance, they pay more — squeezing their cash flow and increasing the risk of future defaults.

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## The Liquidity Crisis: When Investors Can't Get Their Money Out

### The Redemption Surge

One of the most alarming developments in private credit is the rush of investors trying to get their money out. Redemption requests from unlisted BDCs surpassed fundraising in the first quarter of 2026. The Stanger NL BDC Total Return Index posted its first negative quarterly return since 2022.

In Q1 2026, investors requested over **$20 billion** in redemptions. Redemption requests increased from 5.3% of assets in Q4 2025 to nearly 14% in Q1 2026. Funds met only a portion of those requests.

### The Gate Trigger

The crisis has forced some of the biggest names in asset management to trigger redemption gates — restrictions that limit how much money investors can withdraw.

**BlackRock's** private credit fund honored less than **40%** of redemption requests. **Cox Capital Partners** launched tender offers for Apollo fund shares at **70 cents on the dollar** and HPS Investment Partners shares at **75 cents** — discounts of 15% to 30% to stated net asset values. **Partners Group** capped redemptions from an $8.6 billion private equity fund last month after clients pulled $3.8 billion in the first half.

The gap between stated NAV and what investors can actually get in the secondary market — **15% to 30% for some Apollo and Ares funds** — suggests the industry is entering a price-discovery phase that could trigger further write-downs.

### The Structural Mismatch

This is not a temporary problem. It's a **structural mismatch**. Private credit loans are held to maturity and valued internally by fund managers, meaning credit deterioration often does not appear in net asset values until a default or forced sale occurs. Unlike publicly traded debt, private credit doesn't mark to market. The opacity that once made it attractive is now making it dangerous.

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## The Bank Exposure: The Hidden Risk to the Financial System

### The "Shadow" Exposure

Here's the part of the story that should keep regulators up at night. Even though banks pulled back from risky middle-market lending after 2008, they never truly left the ecosystem. Instead, they became behind-the-scenes financiers, providing subscription credit lines, warehouse financing, leverage facilities, and securitization support to private credit funds.

By October 2025, Moody's estimated that U.S. banks had extended nearly **$300 billion** in credit to private credit funds, BDCs, and Collateralized Loan Obligations. The Financial Stability Board recently warned that global banks hold at least hundreds of billions of dollars in direct and indirect exposure to private credit funds.

### The Known Losses

The losses are already showing up:

- **UBS** disclosed more than **$500 million** in exposure to First Brands, whose late-2025 bankruptcy raised early alarms about underwriting standards.

- **Jefferies Group** revealed **$715 million** in what analysts called "questionable receivables" related to First Brands, after allegations that the company had borrowed against the same assets more than once.

- An additional **$170 million** in losses was tied to Tricolor, another distressed private-credit-backed borrower.

- **JPMorgan Chase** reportedly marked down some private credit loans; Moody's put JPMorgan's direct exposure at **$22.2 billion** by mid-2025.

- **Deutsche Bank** disclosed **$30 billion** in private credit exposure.

### The Systemic Risk Question

The ECB has warned that insurance corporations and pension funds could face more material second-round revaluation losses from broader spillovers to leveraged loans, high-yield bonds, and equities. While euro area financial institutions appear to have limited direct exposure to private credit, making it unlikely that private credit in isolation could be a source of systemic financial instability at present, the second-round effects could be significant.

Banks hold an estimated **$2.3 trillion** in contingent liquidity exposure to non-depository financial institutions, including subscription lines and NAV financing facilities extended to private credit funds. That's a lot of leverage tied to an asset class that is suddenly showing signs of serious stress.

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## The AI Connection: The Newest and Most Vulnerable Exposure

### Financing the AI Boom

Private credit has become a major financier of the AI boom. Morgan Stanley estimated that AI data centers would require about **$1.5 trillion** in external financing, with as much as half coming from private credit markets. With fund liquidity freezing, that pipeline is now threatened.

The AI financing channel is particularly vulnerable. AI-related companies account for roughly **45% of S&P 500 market capitalization**, meaning a slowdown in AI capital expenditure could spill over into equity valuations.

### The Hyperscaler Debt

The rapid growth of hyperscaler debt has introduced new correlated risk in investment-grade indexes. Hyperscalers — the giant cloud providers like Amazon, Google, and Microsoft — have added over **$180 billion** in debt since 2025 to fund AI infrastructure buildouts. This debt is often borrowed at rates that could become problematic if the AI boom slows.

### The Double-Edged Sword

AI is both disrupting private credit and being disrupted by it. Substantial improvements in AI capabilities have triggered concerns that the technology could disrupt the business models of some software firms. At the same time, private credit's role in financing AI infrastructure is creating a new layer of risk for the financial system.

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## What This Means for American Investors

### For Individual Investors

If you have money in private credit funds — whether directly or through pensions, endowments, or other institutional vehicles — the stress in the market matters. Redemption gates mean you may not be able to get your money out when you want to. NAV discounts mean what you think your investment is worth may not be what you can actually get for it.

The gap between stated NAV and secondary market prices — 15% to 30% for some funds — suggests that the industry is entering a price-discovery phase that could trigger further write-downs.

### For Institutional Investors

Pension funds, insurers, and endowments that have piled into private credit are now facing a reckoning. The asset class that promised higher yields with lower volatility is delivering higher yields and higher volatility. The illiquidity premium that was once an advantage is now a trap.

The ECB has warned that insurance corporations and pension funds could face material second-round revaluation losses from broader spillovers to leveraged loans, high-yield bonds, and equities.

### For the Broader Economy

The stress in private credit is not an isolated problem. The Financial Stability Board recently warned that global banks hold at least hundreds of billions of dollars in direct and indirect exposure to private credit funds. If those exposures turn into losses, they could ripple through the banking system.

More than $620 billion in private credit debt is approaching maturity between 2026 and 2028. If companies can't refinance, they default. If they default, their lenders take losses. If their lenders take losses, they pull back on lending. The cycle feeds on itself.

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## The Silver Lining: Not All Private Credit Is Created Equal

### The Dispersion Story

Not every private credit investment is troubled. BlackRock's analysis finds that recent stress has been **concentrated among specific borrowers, sectors and vintages**. The market is becoming increasingly differentiated beneath the surface.

Fundraising has diverged across vehicles. Business development companies (BDCs) have experienced modest net outflows, while closed-end private credit fundraising has remained resilient. Some managers are navigating the stress better than others.

### The Yield Premium

Private credit continues to offer a yield premium over public markets. Direct lending yields continue to compare favorably with both leveraged loans and high-yield bonds. For investors willing to be selective, the opportunity may still be there.

### The "Private Credit 2.0"

As Morgan Stanley strategist Vishwas Patkar put it: "Private credit faces higher defaults, but risks are not systemic. We expect limited spillovers to the economy/public markets. **Private credit 2.0 will likely differ, with a focus on higher-quality underwriting and infrastructure financing for AI as a key driver**".

The industry may be going through a painful but necessary cleansing. The easy-money era is over. The era of careful underwriting is beginning.

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## Frequently Asked Questions (FAQs)

### 1. What is private credit and how big is it?

Private credit is a $2 trillion industry of non-bank lenders providing loans to companies that can't or won't borrow from traditional banks. It includes direct lending, mezzanine debt, distressed debt, and specialty finance.

### 2. How bad are private credit defaults right now?

Fitch Ratings reported that the U.S. private credit default rate hit a record **6.0%** in April 2026 and climbed to **9.5%** in July 2026. Private-credit-backed corporate borrowers experienced a **9.2%** default rate in 2025.

### 3. What are "shadow defaults" and "bad PIK"?

Shadow defaults are instances where borrowers are struggling but haven't officially defaulted. "Bad PIK" refers to payment-in-kind structures where borrowers pay interest with more debt rather than cash — often a sign that a company can't generate enough cash to service its obligations. These hidden stresses are nearly three times their 2021 levels.

### 4. Why are investors rushing to get their money out?

Investors requested over **$20 billion** in redemptions in Q1 2026. Redemption requests at non-traded BDCs reached an average **10.3%** of shares outstanding, more than double the typical 5% quarterly repurchase limit. Funds have been forced to trigger redemption gates, honoring less than 40% of requests in some cases.

### 5. Are banks exposed to private credit stress?

Yes. By October 2025, Moody's estimated that U.S. banks had extended nearly **$300 billion** in credit to private credit funds. JPMorgan has **$22.2 billion** in exposure, Deutsche Bank has **$30 billion**, and banks hold an estimated **$2.3 trillion** in contingent liquidity exposure to non-depository financial institutions.

### 6. What is the "refinancing wall"?

More than **$620 billion** in private credit debt is approaching maturity between 2026 and 2028. Companies will need to refinance this debt at much higher rates than when the loans were originated, increasing the risk of defaults.

### 7. How does AI affect private credit?

Private credit has substantial exposure to the software sector, which is being disrupted by AI. At the same time, private credit is financing the AI boom — Morgan Stanley estimates AI data centers will require about **$1.5 trillion** in external financing, with as much as half coming from private credit.

### 8. Is this the next financial crisis?

Probably not on its own. Most analysts don't see systemic risk to the banking system. But the stress is real, and the second-round effects — spillovers to leveraged loans, high-yield bonds, and equities — could be significant.

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## Conclusion: The End of the Golden Age

The private credit industry is facing its biggest challenge in about a decade. The loans that were made during the boom times of 2020 and 2021 are now coming due, and many of them can't be repaid. The companies that borrowed heavily are struggling. The funds that lent to them are taking writedowns. The investors who poured money into private credit are trying to get it out.

The stress is no longer hidden. The non-accrual rates are at decade highs. The default rates are at record levels. The redemption gates are triggering. The NAV discounts are widening. The bank exposures are becoming visible.

David Golub said it best: **"We're in a credit cycle. Others denied it for a while. I don't think there's a lot of denial any more"**.

The golden age of private credit is over. The easy-money era that fueled its growth is behind us. What comes next is a period of painful adjustment — a cleansing of the excesses of the boom years, a repricing of risk, and a re-evaluation of what private credit is really worth.

For investors who can weather the storm, there may be opportunities. The yield premium is still there. Some managers are navigating the stress better than others. And as Morgan Stanley's Vishwas Patkar noted, "Private credit 2.0 will likely differ, with a focus on higher-quality underwriting and infrastructure financing for AI as a key driver".

But for now, the stress is real. The losses are mounting. And the hidden risks that were once private are now public.

The secret is out.

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## Disclaimer

*This article is for informational and educational purposes only and does not constitute financial, investment, tax, or legal advice. All views expressed are based on publicly available information as of August 17, 2026. Market conditions, default rates, and investment performance are subject to change. The author does not endorse any specific investment strategies or products. Past performance is not indicative of future results. Before making any financial or investment decisions based on the content of this article, please consult with qualified professionals who can evaluate your specific situation. The author is not affiliated with the Financial Times, Fitch Ratings, Moody's, BlackRock, or any other entity mentioned in this article.*