Private credit strains widen as defaults and growth pressures mount

A wave of stress signs emerging across the global private credit market is prompting closer scrutiny from investors and analysts, with covenant defaults climbing, leverage rising and slowing earnings growth among private companies shaping the outlook for direct lenders and credit managers. Recent proprietary data from valuation specialists and market trackers show covenant default rates creeping higher compared with historical averages, while a combination of weaker cash flow performance and elevated leverage is increasingly visible across segments of the private credit landscape.

Private credit, which has grown substantially over the past decade as a source of financing for leveraged buyouts and corporate expansion, is now facing headwinds as macroeconomic and sector-specific pressures test borrower resilience. Proprietary index data tracking thousands of portfolio companies indicate covenant defaults have risen to around 3.4–3.5 per cent of loans, up from lower levels previously, while smaller borrowers with limited earnings show particularly elevated stress.

Lenders and credit managers point to a combination of slowing earnings before interest, tax, depreciation and amortisation growth and an increase in leverage since deal origination as key factors constraining borrowers’ ability to reduce debt burdens organically. While larger mid-market companies continue to post positive earnings growth, performance at smaller enterprises is weaker, and these firms are likelier to breach covenants tied to financial health.

The uptick in covenant defaults, while not yet at levels typical of severe credit crises, has drawn attention because of the opacity that surrounds private credit transactions. Unlike public debt markets, direct lending deals are bilateral and lack the transparency of traded securities, complicating real-time assessment of credit quality. This opacity has amplified investor concerns about the market’s overall health and fuelled debate over risk exposure.

Market watchers examine these developments against a backdrop of broader stresses in related credit markets. A downturn in software sector valuations has reverberated across asset managers and lenders, with some large firms reporting notable declines in exposure to technology loans and leveraged structures. Slower revenue growth and high leverage ratios in technology companies have heightened questions about default risk in portfolios with significant exposure to tech borrowers.

The private credit asset class has long been viewed as a resilient alternative to bank lending, offering investors higher yields and more bespoke financing structures. Total assets under management in private credit have expanded dramatically over the past decade, supported by institutional capital seeking diversification and yield. Yet with that growth comes questions about credit quality and whether the rapid expansion has outpaced the market’s underlying capacity to absorb stress without broader disruption.

Participants in the market stress that the rise in defaults does not necessarily indicate systemic weakness. Some analysts argue that recent high-profile corporate failures have been mischaracterised as private credit problems, when in fact they involved other lending structures such as broadly syndicated loans or receivables factoring that are not core private credit products.

Despite this debate, the data reveal that leverage in private credit portfolios has increased since origination. Leverage ratios that were manageable at the time of deal closure have grown as borrowers have relied on adjustments such as payment-in-kind interest arrangements, which allow interest to accrue rather than be paid in cash. These “PIK” features have become more common, particularly among smaller borrowers, and have raised concerns that hidden stress may be accumulating beneath surface growth figures.

At the same time, established private credit managers emphasise that fundamentals remain constructive for many larger credits, especially in the upper middle market where covenant default rates are significantly lower and EBITDA growth remains robust relative to smaller firms. This divergence highlights a bifurcation in credit performance that could shape investor strategies and risk appetites as the market evolves.

Institutional investors are weighing these mixed signals carefully. While some see the current environment as a time to exercise caution and tighten underwriting standards, others view it as an opportunity to deploy capital selectively into credits with strong cash flows and defensible business models. The dialogue reflects broader questions about the role of private credit in diversified portfolios and how best to balance yield prospects against risk.