Private Credit / Credit
Private credit's mark-to-model problem
An asset class that grew up in a decade of falling defaults is now being tested on the one thing it never had to prove: how it prices a loan that is going wrong.
Private credit's growth was not a fad. Banks retreated from mid-market lending for regulatory reasons, and someone had to fund the borrowers. The structural argument is sound. The cyclical question is different, and it is about valuation rather than volume.
Where the marks come from
A traded loan has a price because someone traded it. A private loan has a valuation because a model produced one, informed by a comparables set and signed off by a valuation agent whose fee is paid by the manager. That arrangement is not fraudulent, and it is also not independent in the way an exchange is.
The consequence is not systematic overstatement so much as smoothing. Reported volatility is lower than economic volatility. Investors who buy the low correlation are buying an artefact of measurement, and they will discover this in the quarter it stops working.
The absence of a price is not the same as the absence of a loss.
The tells worth tracking
- Payment-in-kind income as a share of total income. PIK is a legitimate structure and a useful stress indicator, because it converts a cash problem into an accrual.
- Amendment activity. Covenant relief granted quietly is the private market's version of a downgrade.
- Net asset value loans at the fund level: borrowing against a portfolio to fund distributions moves leverage up the structure, where it is least visible.
- The spread between what two different lenders mark the same borrower at, when it can be observed. It is often wide.
The liquidity mismatch
The newer risk is distribution. Semi-liquid vehicles sold to individual investors promise periodic redemption from a portfolio of illiquid assets, managed by gates that work exactly as designed and are experienced by customers as a betrayal. Gates do not create losses. They do create a stampede towards the exit before they are imposed, which is a self-fulfilling mechanism with a long history.
Why this matters beyond the asset class
Private credit is now a meaningful lender to sectors with their own problems: software companies valued on multiples set in a different rate environment, data centre developers, and consumer lenders. When those borrowers stress, the losses are absorbed in vehicles that report quarterly, hold assets that do not trade, and are increasingly owned by retail investors and insurers. That is a slow-motion transmission channel rather than a bank run, which makes it less dramatic and more prolonged.