FT Alphaville
Private credit gets the once-over
Most Important Insight
Private credit has evolved into a procyclical 'rattlebag' of low-quality loans rejected by the CLO market, with an adjusted default rate of 5.4% once 'bad PIK' restructurings are accounted for.
Most Original Insight
The widespread use of 'bad PIKs'—payment-in-kind provisions inserted mid-deal rather than at inception—is a hidden form of default that brings private credit's true failure rate in line with the broadly syndicated loan market.
Key Points
- Private credit is increasingly acting as a lender of last resort for companies rejected by the collateralised loan obligation (CLO) market due to poor creditworthiness.
- Industry fee structures and GP incentives are heavily oriented toward rapid capital deployment rather than disciplined portfolio construction.
- Portfolio standards have deteriorated, with some managers maintaining 40-50% exposure to the software sector despite emerging AI-driven competitive threats.
- The adjusted default rate for private credit is estimated at 5.4% when including non-accrual loans and mid-deal PIK switches.
- A massive influx of insurance capital is creating permanent deployment pressure, keeping spreads artificially narrow even as credit risks rise.
- Recovery rates for defaulted private credit loans are expected to be materially lower than historical norms due to the asset-light nature of modern borrowers.
- The 2021 leveraged buyout (LBO) vintage is identified as a specific disaster area due to blocked exits and creative accounting practices.
- The procyclical nature of the private credit business model incentivizes managers to find transactions even as the risk-reward balance deteriorates.
Investment Implications
| Asset / Sector / Instrument | Action | Source | Notes |
|---|---|---|---|
| Broadly Syndicated Loans | HOLD | implicit | The author notes that truly creditworthy companies still prefer the CLO/syndicated market over private credit. |
| Private Credit (Software Sector) | SELL | explicit | The author warns of extreme 40-50% concentration in software companies facing 'SaaSpocaplyse' and AI disruption. |
| 2021 LBO Vintage | SELL | explicit | This specific vintage is described as a 'disaster' characterized by blocked exits and rising default rates. |
| Private Credit (General) | SELL | implicit | The market is characterized as a collection of 'cruddy loans' with recovery rates likely to be materially worse than history. |
Hang on a sec…
- The claim that 'bad PIKs' are 'just another form of default' ignores that these restructurings are often strategic tools used to preserve enterprise value and avoid the friction costs of formal bankruptcy.
- The assertion that 40-50% software exposure is a sign of poor management fails to acknowledge that software has historically provided the most stable recurring cash flows for debt service.
- The argument that insurance capital prevents valuation adjustments assumes these highly regulated entities are price-insensitive, ignoring their internal risk-based capital (RBC) constraints.