Private Credit's Hidden Stress Signals Demand Investor Scrutiny

What's New

Recent bankruptcies like First Brands and Tricolor Food Group are likely "canaries in the coal mine" signaling broader underwriting problems across private credit markets. According to Morningstar's The Long View podcast, private market analyst Leyla Kunimoto argues that a decade of cheap money chasing deals has produced loosened covenants and compromised oversight, with stress now emerging as borrowers struggle under higher rates.

Why It Matters With trillions flowing into private credit from retail investors seeking yield, the opacity of these markets masks growing stress. Unlike public markets with clear default definitions, private credit's bespoke loan structures allow borrowers to defer cash payments through payment in kind mechanisms, creating an illusion of health while fundamentals deteriorate beneath the surface.

Big Picture Drivers

• Capital surplus: Massive inflows forced rapid deployment, likely compromising underwriting rigor and covenant protections

• Opacity by design: Private markets lack standardized disclosure requirements, leaving investors with limited visibility into borrower health

• Sales side dominance: Most voices in private markets represent general partners or wealth channels, not independent limited partner perspectives

• Liquidity mismatch: Retail investors face effectively no exit options for smaller stakes under $1 million, unlike institutional players accessing robust secondary markets

• Regulatory gap: Private credit exists outside traditional banking oversight, dispersing risk across private capital without systemic safeguards

By The Numbers

• 6% to 11%: Range showing how PIK ratios can climb quarter over quarter at stressed lenders

• $1 million+: Minimum stake typically required to access secondary market liquidity

• 10+ years: Period of historically low default rates in private credit now showing cracks

• Lowest in a decade: Current DPI (distributions paid on capital) levels across private equity vintages

• 25%: Example discount at which secondary funds can acquire stakes, then immediately mark to full NAV

Memorable Quotes

• "I don't think these are isolated cockroaches. There are probably more cases of stretched borrowers and loans that were issued with a little bit less oversight."

• "PIK is about the only measurable thing in those financial statements... it's the best I got."

• "You can't eat IRR." (citing Howard Marks on the limitations of internal rate of return as a performance metric)

• "In private markets, fair market value is whatever the fund manager marks it at, regardless of what I buy it at."

• "The train of access to private markets for retail investors is common. It's well on its way, and I think it would be unwise to think that anybody is going to stop it."

Key Trends to Watch

• PIK escalation: Payment in kind percentages climbing in quarterly BDC filings signal borrower distress before defaults officially surface.

• DPI compression: Historically low distributions indicate a massive liquidity backlog as private equity exits slow dramatically.

• Secondary fund proliferation: Accounting rules allowing instant markup of discounted purchases create artificial returns that attract more retail capital.

• Retail access expansion: Major brokerages acquiring private market platforms will reshape liquidity options within five to ten years.

The Wrap

Investors entering private credit and private equity must look beyond headline returns to examine PIK ratios, maturity schedules, debt structures, and the true liquidity of their positions. The metrics that matter most—DPI, equity multiples, and cost basis transparency—require digging into footnotes that some funds deliberately obscure. Until accounting standards change and independent voices gain traction, retail investors face an information disadvantage that no yield premium fully compensates.