Private Credit Faces a Reckoning as Cheap Money Ends

Private credit was shaped by ten years of ultra-low borrowing costs and plentiful cash, which made debt loads look safer and muted danger. That backdrop is now reversing, with consequences far outside lending itself, for asset allocation, how holdings are valued and how risk is priced across markets.

How ultra-low rates built a $2trn market

The industry expanded from about $500bn in 2015 to perhaps $2trn or more now by offering investors — among them pension schemes, insurers and, increasingly, retail savers — a compelling, steady income with protection on the downside.

Rock-bottom rates and the search for return drove money into unlisted markets and promoted balance sheets designed for inexpensive borrowing and smooth disposals. That pattern has now broken down at its core.

Why refinancing has turned harder

Elevated borrowing costs have rewritten the price of money. Private equity, historically the source of transactions and cash returns, has decelerated, with routes out including takeovers, mergers and flotations constricting and ownership tenures extending far past earlier averages.

Money is effectively stuck. Rolling over debt has grown tougher.

An approaching wall of maturities is forcing inexpensive borrowings to refinance at dearer levels. At the same time, conventional banks have pulled back, while industry-specific shocks have intensified, ranging from AI-led revaluation in software to persistently elevated power prices, notably across Europe.

The geopolitical setting has also changed. The extended calm era when indebted companies benefited from global integration has yielded to a more fractured order, bringing greater costs of operating.

What distress will look like

Numerous borrowers face a jolt, with debt servicing repricing to double or triple pre-2022 levels, when markets started reassessing risk after the long boom. Certain businesses will adjust, defending profitability and reshaping liabilities.

Others will discover that refinancing cannot re-establish viability. What separates them will be the fundamental durability of each enterprise.

Why software faces strain first

Software will probably be the earliest of several sectors where such strains burst forth. Backers believed they were gaining access to spread-out, resilient, even dull private debt. In practice they acquired indebted, heavily bunched exposure to one industry where recoveries in a slump tend to be modest.

Software’s boom years will be recalled as a serious failure of risk oversight. Plenty of software companies loaded up on borrowings in the easy-money period, aiding growth of the sector from roughly $8bn in 2015 to $500bn by the end of 2025.

Yet that borrowing was frequently premised on bold expansion forecasts instead of lasting cash flow. At present both the commercial and funding approaches of the industry face severe pressure. AI is reducing entry hurdles, allowing rivals to rapidly and inexpensively copy distinctive features and processes. Costlier finance is laying bare delicate balance sheets founded on hopeful projections.

There are set to be victors, especially businesses capable of deploying AI successfully. Still, for numerous creditors, performance will probably face intense strain. Software groups usually own few tangible assets, constraining recoveries when conditions weaken.

Once equity worth is damaged, keeping top engineers can likewise grow hard. Those forces may reinforce one another during a workout. Creditor recoveries could undershoot past norms, and in frailer instances might sink far under 50 cents on the dollar.

Evidence of this turn already shows in listed debt markets, where software borrowers pursuing leveraged finance find it hard to secure sufficient appetite at a funding cost they can sustain. Within unlisted markets those stresses require more time to emerge, as lenders renegotiate facilities and delay cash interest to buy time. Failure rates remain deceptively subdued.

Delayed risk, not diminished risk

The recent placid phase fostered an impression that danger had been permanently diminished. In truth, it had frequently just been postponed.

Such behaviour is scarcely novel in markets — indeed, today’s shift fits a familiar sequence: when circumstances normalise, excessive confidence gets corrected; and such correction compels a re-evaluation of risk plus a tighter deployment of money.

A slow workout, not a systemic crisis

Notwithstanding the asset-allocation and origination errors of the years after the global financial crisis, private credit poses no systemic danger to finance as a whole. Unlike 2008, such obligations do not sit concentrated within highly geared banks. In that respect, much post-crisis reform has functioned as designed.

The adjustment will unfold over years, not months, and handling troubled borrowings will consume significant attention and capacity, curbing private-debt houses’ scope to evolve in a rapidly shifting marketplace. Yet the threat of broad contagion looks contained.

Even so, the lending premises of the prior decade, grounded in low-cost funding, dependable expansion and foreseeable disposals, should now be abandoned. The changed climate demands a much more detailed examination of staying power, rather than growth alone.

It is a private-debt landscape marked less by sweeping defaults than by growing divergence among successes and failures. Openings will still appear. For backers who can tell short-term disruption from permanent damage, the aim will be to commit money at better starting valuations and to restructure liabilities to re-establish health.

Today’s private-credit narrative is not one of surplus collapsing into emergency. It concerns an institutional shift away from a time of copious, indiscriminate funding toward one where cash is contingent, origination must be fine-grained and results become progressively more uneven. The process will not trigger a wider market collapse, yet expect it to cause substantial hardship — while, as ever, offering those most equipped for rougher conditions an opening to hunt for value.■

Hamza Lemssouguer is the founder and chief investment officer of Arini, a credit investment firm with $20bn under management.

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