Private Credit: When the Music Plays—And What to Watch When It Stops

Over the past few years, private credit has moved from the periphery to the heart of institutional portfolios. It's being pitched everywhere—from private banks to fund sponsors—as a rare sweet spot in today's markets: attractive yields, low volatility, and steady performance. The messaging? “It’s like equity returns with bond-like risk.”

But if there’s one thing I’ve learned from advising endowments, large family offices, and institutional clients, it’s this: there is no return without risk—especially when it feels like there is.

Let me start by saying: I’m not skeptical about private credit. I’m invested. My clients are invested. There’s tremendous value in the asset class. But part of our role as fiduciaries is not to sell certainty—but to equip people to see clearly, especially when an investment theme gets too comfortable, too widespread, and perhaps—too under-examined.

The Backdrop: What’s Changed in 2025?

Private credit is no longer a fringe activity. The market has ballooned to $1.7 trillion+ in the U.S. alone, and it's still growing fast. That growth is now attracting scrutiny from the Federal Reserve, not because it’s inherently dangerous, but because it has outpaced regulation, transparency, and understanding.

Here are four dynamics that are shaping the risk landscape:

1. Private Credit is Growing—So is Systemic Risk

Private credit operates largely outside the traditional banking system, but increasingly intersects with it. Business development companies, direct lenders, and alternative funds are taking on lending roles once dominated by banks. But they are not subject to the same capital rules or supervisory scrutiny.

2. Banks Have Indirect Exposure

Even though banks aren’t directly making the riskiest loans, they are providing funding lines to private credit platforms. In doing so, they may be unknowingly taking senior exposure to riskier loan books—a structure eerily reminiscent of pre-2008 CDO tranches.

3. Regulatory Blind Spots Remain

Inside the Fed, there's no clear consensus on what to do. Some regional Fed presidents are raising alarms. Others, especially incoming leadership figures, are focused on shrinking—not expanding—the Fed’s oversight role. This means private credit is too big to ignore, yet too opaque to regulate effectively.

4. Liquidity Risk is the Core Concern

The biggest existential threat isn’t necessarily credit defaults—it’s a sudden freeze in funding. If banks or LPs pull back from funding these vehicles, redemptions could be gated, NAVs marked down, and credit flow to mid-sized companies choked off.

And here’s the kicker: We’ve never experienced a full economic downturn with private credit playing such a central role. This market has never been truly stress-tested in a recession—at least not at this size and with this much interconnectedness with the banking system.

What the Metrics Are Telling Us

As allocators, we need to do more than listen to the music—we need to watch the rhythm underneath. Here are the early warning signs I monitor across our portfolios:

• PIK (Payment-in-Kind) loan exposure: When borrowers stop paying interest in cash and start rolling it into their loan balance, it’s a signal of liquidity strain. A small % is normal. But when PIK exposure exceeds 10%, it’s time to dig deeper.

• Cash-pay ratio: Healthy portfolios should have the majority of borrowers paying real interest. If the cash-pay % drops materially, that’s stress.

• Default and restructuring trends: Even modest increases can signal cracks beneath the surface.

• Spread widening: If credit spreads start to blow out, private credit portfolios—especially levered ones—will get marked down.

• Liquidity terms: Evergreen funds with quarterly redemption rights sound good—until markets freeze. Understand your exit options in advance.

Practical Advice I Offer to Clients

1. Don’t confuse illiquidity premium with free lunchPrivate credit is often marketed as stable, low-volatility yield. But that “stability” is often a function of mark-to-model pricing, not real-time market stress. Returns are attractive because you’re giving up liquidity—not because risk has disappeared.

   
   

2. Stress test proactivelyRun scenarios where:

   • Default rates hit 3–5%.

   • Borrowers defer cash payments (PIK spikes).

   • Liquidity tightens and redemptions are suspended.

   Ask: what does this do to my income, NAV, and rebalancing ability?

   
   

3. Size your allocation based on purpose and liquidityFor many portfolios, a 10–20% allocation to private credit makes sense—anchored in senior, secured credit with reliable cash flows. Opportunistic, sector-specific, or NAV-based credit may warrant <5% exposure due to higher volatility.

   
   

4. Ask your managers the uncomfortable questions

   • What is your current PIK exposure?

   • How are you preparing for a downturn?

   • Have you modeled systemic liquidity events?

   • What % of your borrowers are in sectors under pressure (e.g., real estate, consumer)?

     
     

5. Watch how managers behave under pressure. Managers who are transparent, conservative in underwriting, and proactive with portfolio management are the ones you want to stay with during volatility. Avoid strategies chasing yield at the expense of credit quality.

A Mindset of Vigilance, Not Fear

I’m not saying the private credit “party” is over. But the dance floor is getting crowded, the music is louder, and some people are forgetting where the exits are. My message isn’t to run—it’s to know what to watch, ask better questions, and prepare your portfolio for the full cycle.

Private credit still belongs in the portfolio. But the way we allocate it, size it, and monitor it must evolve. Because when the cycle turns—and it always does—resilience won’t come from flashy returns. It will come from the rigor and humility we bring to portfolio construction today.

Let’s keep learning, keep asking, and keep lighting the way forward—together.