Crunch time: Why less is often more in private credit

Produced in partnership with Barings.

The private credit sector has had a pretty good decade, with the exception of the last 12 months. After a period of strong performance and record inflows, conditions are turning, although the broad themes that underpinned the rise of private credit haven’t changed. There is still a credit demand and supply mismatch, as corporates seek capital to fund expansion and innovation while traditional banks continue tightening their credit criteria and withdrawing from sections of the market, due to stricter regulatory controls.

What has changed is investor nervousness about interest rates and the private credit sector’s high exposure to struggling sectors like software and technology, sparking mass redemptions.

This dynamic has exposed some lax standards in the industry and created a catalyst for investors to reexamine the strong case for private credit. It has also provided an opportunity for good managers to demonstrate the efficacy of their investment and risk management systems and processes.

Sound fundamentals are critical

Underwriting is a critical, fundamental principle in banking and lending.

It is the task of evaluating loans to individuals and companies and assessing the risk of defaults by examining factors like credit history, ability to repay debt and the asset being financed. It involves assessing business models, cashflows, capital expenditure, profitability, key people and equity counterparts.

External factors, like operating environment and market conditions, also need to be considered.

In private credit, the process of assessing applications is typically more vigorous and stringent than traditional bank lending, reflecting the higher risk often associated with private markets.

Private credit offers investors potentially higher income yields, protection against inflation and diversification benefits, given the sector’s low correlation to public equity and bond markets, however, it generally carries higher credit risk and lower liquidity.

Most private market funds are closed-ended structures that pool capital from multiple investors and have a fixed investment timeframe of between five-to-10 years. Even with the creation of innovative evergreen structures, which provide quarterly and, in some cases, monthly redemptions, investors still can’t access their money quickly.

In addition, there is the risk of a liquidity mismatch if redemption requests exceed the cash generated by underlying loans.

This scenario is currently playing out, with the term ‘SaaSpocalyse’ being used to describe the rapid sell-off of tech stocks and spike in defaults since the start of 2026.

Defaults have jumped to around 5 per cent to 6 per cent compared to around 1 per cent to 3 per cent during the period from 2015 to 2021, according to Fitch.

Less is more

While private credit is the broad overarching catch-all for non-bank loans, within that category there is a plethora of managers, each with their own style, specialisation and standards. Private credit managers are not a homogeneous bunch, requiring investors and advisers to be deliberate and discerning about manager selection.

They should look for managers with a proven long-term track-record of managing credit portfolios through economic cycles, a disciplined risk management framework and a large, experienced team of investment professionals.

Ideally, managers should have strong relationships with equity sponsors, like private equity firms, to ensure access to deals and, if necessary, support in turning around any underperforming loans.

Private credit managers need to be disciplined, not only when it comes to the companies and loans they take on but having a structured and intentional strategy around the size and composition of their portfolio and assets under management because, in credit, less is often more.

This is certainly the position of traditional banks, which have been retreating from lending to certain sectors, since the 2008 Global Financial Crisis.

Private lenders have stepped into the gap, providing much-needed capital and debt funding for companies to expand, improve operations and innovate. They play a vital role in driving economic growth and delivering attractive yields to investors.

As a result, the private credit market has quadrupled to $3.5 trillion in assets under management over the past decade and is expected to hit $5 trillion by 2029, according to the Reserve Bank of Australia.

But as demand for private credit grows, so does the need to be disciplined and say no – no to bad loans and no to amassing assets under management.

Significant inflows increase the risk of underwriting standards and covenant protections slipping, as managers seek to deploy capital. Without robust systems and processes in place, managers could be tempted to underwrite loans that they wouldn’t have in more rational markets.  

To protect investors, underwriting must always take precedence over raising capital. After all, underwriting drives performance and differentiates managers.

This is an edited extract from the Professional Planner Investment Innovation Guide. Click here to read the full article.

Jonathan Baird is head of Australian wealth distribution at Barings and a member of the global business development group.