Private Credit's Calm Surface Masks a Dispersion Problem That Will Create the Next Cycle's Best Opportunities, Oaktree's Poli Argues

What's New

The private credit market looks stable at index level, but underneath, dispersion between higher and lower quality borrowers is widening to levels that signal real stress ahead. Danielle Poli, Managing Director and Co-Portfolio Manager of Oaktree's Global Credit strategy, makes this case in a conversation on Alt Goes Mainstream. Poli, who sits at the intersection of liquid and illiquid credit, argues that software, which represents roughly 20% of the direct lending market, has experienced a sector-level disruption from AI that coincided with a 500 basis point rate shock, creating what she calls a perfect storm for the 2020 to 2022 vintages. For allocators, the implication is that the window for opportunistic and rescue lending is approaching, and managers with cycle-tested underwriting discipline will capture the dislocation while those who deployed aggressively into perpetual vehicles face the consequences.

Why It Matters

Private credit attracted record capital flows on the premise of stable, yield-generating assets with limited downside. Poli's argument challenges whether that premise holds for recent vintages. If payment-in-kind modifications running at 11 to 12% mask stress that would otherwise appear as defaults in liquid markets, then reported performance in semi-liquid vehicles may overstate actual credit quality. The counterargument is that the AI infrastructure buildout and strong employment are generating enough economic tailwind to prevent a full credit cycle, giving overleveraged borrowers time to grow into their capital structures.

Big Picture Drivers

• Software's fall from grace in private credit: Software was the darling sector for direct lending because of its recurring revenues and sticky customer base, but AI disruption and a 500 basis point rate increase hit simultaneously. Software and IT now make up about 40% of the stress in the lower-rated cohort within the leverage loan market. Some of Oaktree's funds carry as low as 4% software exposure compared to the 20% market average, a positioning Poli attributes to underwriting discipline.

• Payment-in-kind interest as a stress indicator: PIK modifications, where borrowers defer cash interest payments, are running at approximately 11 to 12%, near historical highs. Poli frames this plainly: there is no good PIK, only bad PIK and worse PIK. If a company cannot pay interest in cash, it signals stress that bilateral agreements allow managers to mask rather than report as defaults.

• Asset-backed finance as the diversification play: Poli argues that investors who have already built direct lending portfolios should diversify into asset-backed finance, which provides contractual, uncorrelated cash flows ring-fenced from a borrower's other obligations. Oaktree has been channeling capital into ABF rather than competing for compressed-spread direct lending deals.

• Liquid credit as a strategic option, not a fallback: In Oaktree's multi-strategy portfolios, two-thirds of assets sit in liquid credit and one-third in private credit. This allocation allows the firm to avoid forced deployment into private credit when spreads compress and to sell positions when software names bounce, as they did at the end of Q1 when Oaktree used the recovery to reduce exposure.

• The approaching maturity wall: Lower-rated borrowers face an upcoming wall of maturities that will force refinancing in a higher-rate environment. Triple-C cohort spreads in leverage loans have widened about 300 basis points this year, with yields reaching 25%. Poli sees this as the signal that opportunistic and rescue lending opportunities are forming.

By The Numbers

• 300 basis points of spread widening in triple-C leverage loans this year, while double-B spreads have tightened

• 25% yields on the most stressed cohort of leverage loans

• 20% of the overall direct lending market concentrated in software

• 11 to 12% PIK modification rates in private credit, near historical highs, compared to a 3 to 4% average default rate in liquid credit

• $7 trillion in estimated financing needed for AI infrastructure buildout

• 4% software allocation in some Oaktree funds versus the 20% market average

Key Trends to Watch

• Opportunistic and rescue lending window opening: Poli sees sizable opportunities forming in software, building products, consumer products, and healthcare as overleveraged borrowers hit maturity walls. She frames the current moment as preparation rather than deployment, with the actual window likely arriving in the next 12 to 18 months.

• Credit versus equity reallocation accelerating: With PE multiples at historically elevated levels, Poli cites JP Morgan research showing that at 22 times forward earnings, 10-year equity returns have historically ranged from negative 2% to positive 2%. Credit, by contrast, has delivered high single-digit income through comparable periods, prompting institutional investors, including endowments, to shift allocations from equities into credit.

• Hybrid and barbelled credit strategies gaining traction: As the boundary between liquid and illiquid credit blurs, Poli expects more products and allocation frameworks that combine core liquid credit positions with selective private credit deployment, allowing managers to be opportunistic rather than forced buyers.

Memorable Quotes

• "There really is no good PIK. There's bad PIK and worst PIK." Poli cuts through the industry's attempt to distinguish between payment-in-kind structures, arguing that any borrower deferring cash interest is signaling credit stress regardless of the framing.

• "I don't think we've seen a sector like that fall from grace so quickly." Poli describes software's reversal from private credit's most favored sector to its largest source of stress, a shift driven by AI disruption coinciding with rate increases.

• "The market is very complacent right now. We were going to invade Greenland, we bombed Iran twice, you had Suspocalypse. These are a lot of things that didn't do much to spook the equity markets or the credit markets." Poli catalogues the geopolitical shocks that failed to trigger repricing, arguing that AI infrastructure spending is creating a positive tailwind that masks underlying credit deterioration.

• "Boring is beautiful for now. The best is yet to come." Poli's proposed memo title encapsulates Oaktree's current positioning: collect stable income from liquid credit while preparing for the dislocation that will create the next generation of high-return opportunities.

The Wrap

Poli's thesis succeeds if the dispersion she identifies in lower-rated credit continues to widen and if PIK modifications eventually convert into defaults or distressed exchanges that create a meaningful opportunity set for rescue capital. The test is whether the AI infrastructure tailwind and strong employment data extend the cycle long enough for overleveraged borrowers to refinance or whether the maturity wall forces a reckoning that validates Oaktree's defensive positioning. If the macro environment stabilizes and spreads compress across quality tiers, Oaktree's underweight to private credit and software may look like overcaution rather than prescience. The next 12 to 18 months of maturity wall outcomes and PIK-to-default conversion rates will determine whether boring truly proves beautiful.