Is US Private Credit sector headed for 2007-08 redux? S&P Ratings’ Ramki Muthukrishan unpacks the details

We have been hearing a lot about private credit for the last six or seven months. It first made headlines when Tricolour Holdings and First Brands defaulted in September 2025. Now, we are hearing extreme views—some experts from the US say this is 2007-08 credit crisis redux, while others say they are incomparable. So, for us in India to understand what is happening, can you begin by simplifying to us what exactly is private credit in the US financial system?

Sure. Put simply, private credit is any type of lending where a bank is completely disintermediated. It is non-bank lending to private entities—that is what it was in its primary form: direct lending. Of course, today, it has become larger, little more complex and involved. You have a whole lot of various funds or vehicles that are available to investors who can access the asset class, but in its primary form, direct lending was the primary strategy for private credit.

Other strategies in private credit include credit opportunity funds, distressed lending, infrastructure real estate, but direct lending in the form of a bilateral agreement or just club lending with a few other private credit lenders was really the primary form of private credit.

It certainly has grown significantly over the last 15 years. I think post Global Financial Crisis (GFC), the size of private credit was about $200-250 billion. Today, the estimates are that it is north of $2.5 trillion. Now, the challenge with private credit is it is an opaque market and hence difficult to size precisely.

So, the banks are not part of this lending, but although they retracted from making direct loans to leveraged middle-market companies, banks did not exit the ecosystem of direct lending altogether. Instead, banks lend to private credit lenders.

What exactly has driven this massive growth from $250 billion to over $2.5 trillion?

There are several things that have driven the growth. First, it’s the change in the regulatory environment with the reforms that were promulgated after the GFC, such as leveraged lending inter-agency guidelines. Those guidelines were a deterrent for banks from lending directly to leveraged middle-market companies. As banks vacated from this spot, lenders like asset managers moved in setting up funds to lend to the senior part of the capital structure.

The second driver was just the low rate of interest following the GFC. Given that inflation was low, you had low rates for an extended period going all the way to the pandemic.

What that meant was institutional investors looked beyond their traditional 60-40 allocation in pursuit of better yields and returns. For institutional investors like insurance companies or pension funds with certain return thresholds to meet, private credit, which offered higher yields, was an attractive investment opportunity.

How does it compete with traditional banking or syndicated loans?

Private credit has competed predominantly with the broadly syndicated loan (BSL) market. There is a certain attraction to private credit in terms of the speed of execution.

Just given the nature of lending, there are very few parties involved in making the decision to lend. That makes the process fast and efficient unlike a syndicated loan market, where you have a bank that goes through the syndication process, and basically have several parties to sort of deal with.

Also, private credit offers efficiencies like a ‘unitranche’ lending (borrower deals with one lender or group, instead of separate agreements for each debt type). So, there is just one class of lender, and there’s no multiple class like second-lien, mezzanine or subordinate lenders in the capital structure, each of whom has to be negotiated with.

And really, in my view, what brought private credit to the centre stage was the predictability it offered in 2022. If you remember, at the start of 2022, when there was the invasion (of Ukraine), the syndicated loan markets nearly froze. Also, there were concerns about inflation and potentially interest rates really ramping up. That predictability was particularly useful for sponsors when the market in 2022 was volatile.

There were large transactions that the syndicated loan market took a while to close, so they were just hung in syndication. That uncertainty meant that business plans couldn’t be unfolded and investments couldn’t be as planned. So the predictability that private credit offered was very much an attractive option for sponsors.

You mentioned that banks are not part of this lending, but they haven’t disappeared from the ecosystem. How are they involved now?

So, the banks are not part of this lending directly, but although they retracted from making direct loans, banks did not exit the world of direct lending altogether. Banks are now lending to private credit lenders. 

Can you quantify what is the exposure of commercial banks in the US to the private credit lenders?

On exposure they have, it is tough to get a sense of how much banks have lent to private credit, but banks lend to what is called non-banking financial institutions (NBFIs).

A portion of NBFI is the private credit part. Bank loans to NBFIs have increased over the years. The Federal Deposit Insurance Corporation (FDIC)-insured banks reported about $1.4 trillion in loans in 2025. This is about 11 per cent of their total loans. Based on S&P research, this is up from about $700 billion in 2020. From 2020 to 2025, they grew at a CAGR of about 14 per cent, in some ways mirroring the growth of the private credit industry.

Can you explain the business model of these companies? What are spreads they charge? How much do they leverage? We hear about terminologies like listed and unlisted BDCs. What are they?

At its core, what private credit does is lend to the middle-market companies, most of which are held by private equity firms. The lending could be through vehicles set up in an asset manager’s fund complex. An asset manager has a whole fund complex. It could be through a GP-LP fund, or you could take leverage and lend through a middle-market CLO or collateralised loan obligation (pooled private loans to mid-sized firms) or a BDC (Business Development Company).

I’ll spend some time on BDCs because they’re very much in the news. They were created by the Small Business Investment Act in 1980. The intent was to provide capital to small- and middle-market entities. This required BDCs to invest or lend about 70 per cent of their capital in private companies or in small public companies with less than $250-million market cap. Now, because these are registered investment companies, they’re required to distribute 90 per cent of their income to shareholders. BDCs are not taxed, which adds an attractive element to it.

Originally, BDCs needed to have a leverage of 1:1 debt-to-equity. In 2018, that was relaxed to 2:1, if they needed to. So, if they have $100 in equity, they could have $200 in debt. Now, there are three types of BDCs:

Publicly-traded BDCs: These are like regular stocks; you can go to an exchange and buy them. They are the most liquid.

Perpetual non-traded BDCs: These are in the news lately. They are not traded in the market, but you have the ability to redeem every quarter, typically with a cap of 5 per cent of your Net Asset Value (NAV).

Private non-traded BDCs: These are more like a draw-down fund, where your liquidity is limited. They have longer lock-in periods, typically a five-seven-year life.

The loans structured in direct lending space, typically, pay 450-500 basis points above the secured overnight funding rate (SOFR). So, for example, if the SOFR is at 5 per cent, they get 9.5-10.5 per cent income on their loans and the returns go up if the vehicle is leveraged. After you meet funding costs, income can be in the high single-digit to low double-digit percentage. Of course, SOFR has come down now and so has the income BDCs generate.

Amongst the different structures within private credit, are BDCs the most significant part?

It is tough to tell, the size of BDCs is north of $500 billion, middle-market CLO about $150-200 billion. It is tough to see which one is the largest, given that many of the funds in the private credit universe are private and there are not too many disclosures or filings.

Let’s talk about those redemptions. As I was preparing for this interview, I just saw news flashing that a BDC managed by Blue Owl Capital received 41 per cent redemption requests but the asset manager is gating it at 5 per cent. Is this a crisis?

Let’s go back a bit here. The increased scrutiny on private credit stemmed when the market incorrectly associated the high-profile defaults of First Brand and Tricolor with risks in private credit lending. First Brand was financed mostly by the broadly-syndicated loan market.

Tricolor was financed completely by the asset-backed securitisation market. Neither of these was part of direct lending funding. Part of the redemption is driven by concerns on the asset class, which were unfounded, and part of it by the AI threat to software to which private credit is highly indexed to.

Regarding capping of redemptions, it needs to be understood that perpetual non-traded BDCs invest in semi-liquid and illiquid assets.

There is a reason that you get a higher return—what some call an “illiquidity premium.” When you have redemption needs that are significantly higher than the 5 per cent cap, it creates a mismatch between what the retail or institutional investor’s liquid needs are and the inherent illiquid nature of the asset the vehicle holds.

The investors going in understand there is a 5 per cent limitation on withdrawal. And so, this is really not gating. The manager cannot liquidate illiquid assets at a substantial haircut to the detriment of the other investors. Our analysis shows there is sufficient headroom either in the form of unencumbered collateral that can be pledged to raise added liquidity, level-2 assets or liquid loans that can be monetised even if there are redemption needs of 5 per cent in the next few quarters.

The industry is also facing criticism due to factors like PIK or ‘payment in kind’ and different asset managers marking the same loans at different price levels.

It is important to differentiate between loans that are structured with the option to PIK and loans that were originally cash pay but experienced liquidity and performance issues at the entity level and convert to PIK.

First, let’s address PIK loans structured via amendments. The rise in SOFR benchmark rates (as Fed increased interest rates) in 2023 and 2024 led to increase in financing costs, putting pressure on the company’s ability to generate sufficient cashflow.

Lenders provided relief via amendments to agreements, allowing issuers to defer their interest payments and address their liquidity challenges. These are viewed as a default by S&P, as there is a breach in terms of payment. This is what the industry calls problem PIKs.

Then there are loans structured with an option to PIK from day one. These are not necessarily problematic, but more an optionality that the loan structure has. The option for lenders to PIK their interest from day one is driven by strategic choices. These loan structures provide financial flexibility and are negotiated with issuers at the time of the financing.

With regard to different asset managers marking the same loan at different levels, the assets in the direct lending space are level-3 assets, which are marked to model. The inputs to model are not standardised and slight change in judgment around inputs can lead to different valuation levels. However, pricing is generally range bound.

You could have a difference if there is information asymmetry; this happens when as lead lenders have more ongoing communication with sponsors and reflect more updated information in their valuation than other group of lenders.

There could be a difference in valuation when there are differences in timing and frequency of valuation too.

Just when the 17-year credit cycle that started from the ashes of the global financial crisis started to unwind, the Gulf War 3 has complicated things even more and it looks like Fed rate hike is more likely than a cut. How does your perspective change on private credit in this context?

Credit is credit, whether it is public or private. To me, the biggest challenge for private credit or BSL loans today is the exposure it has to software. Private equity and private credit both like software because of the predictability of cash flows. It was seen as non-cyclical.

However, the risk of AI disruption is real. In our view, this risk is nuanced. If you are an enterprise resource provider deeply embedded in a company’s workflow, the option of “ripping and replacing” doesn’t really work. Those companies have less of a risk. But for software companies providing services like recruitment/talent management, multimedia strategy, translation services or business intelligence, they are more at risk of being disrupted by AI.

One good thing is that for the loans private credit has made to software companies, they have an LTV (Loan-to-Value) of 30-35 per cent. That means there is sizeable equity of 65 per cent sitting under the 35 per cent loans. Even if the enterprise value shrinks by 50 per cent, the loans are still above water; although in such a case, the LTV might jump from 30 per cent to about 60-70 per cent. The lender will need to figure out options then.

Can you explain how you assess these companies in private credit?

Our credit view on direct lending comes through what we call credit estimates. Credit estimate by S&P is not a credit rating. But it is still a credit opinion on unrated companies that have loans, which collateralise middle-market CLOs that we rate. We use the same methodology, we use the same information requirement and form our insights on their financials, business, growth etc. The only difference is that we don’t have access to management because these are done at the behest of a CLO manager and not issuer.

So, credit estimates are provided to the CLO managers (which could be a BDC). Now, the CLO managers are the same GPs or asset managers that manage other vehicles in their fund complex.

And like I said, when they underwrite a company, they allocate portions of the loans across various vehicles. So, we have 3,500 credit estimates currently.

And if you aggregate the size of the debt of the companies to whom they have lent, that is about $800-850 billion out of the direct lending component within private credit, which has a size of, say, over a trillion dollars. So, we have a fairly big footprint.

Out of this $800 billion of lending that you have a view on, how much is lent to the software sector, which is where fears are spiking in terms of default risks?

Of the 3,500 or so companies we have, I would say over 430, 440 are software companies. In terms of value, it will be around $150-175 billion or 20 per cent of the universe.

What are the default rates in the private credit industry now?

Different institutions have differing default rates given the methodology used to calculate them. Based on the performance of credit estimates, our calculation of default rate on a trailing 12-month basis is 4.45 per cent. We include both traditional defaults like bankruptcy, missed payments, equitisation of debt as well as soft defaults.

For 2025, the biggest drivers of credit estimate defaults have been cash-pay loans that convert to PIK, which accounted for 68 per cent of the total defaults, followed by issuers requesting for maturity extensions (extending loan maturities) without providing adequate and offsetting compensation to investors.

These default rates are higher than S&P calculation of trailing 12-month default rates for speculative grade bonds/loans in the US public market, which was under 4 per cent.

There are macro headwinds with the geopolitical tensions, potential pickup in inflation and rates staying elevated for longer. Then there is the structural transformation that some portion of software industry is going through with the threat of AI disruption.

That said, the companies came to 2026 from a position of strength; based on our review of credit estimates in 2025, revenue and EBITDA went up in 74 per cent and 65 per cent of the cases, while median revenue and EBITDA went up 14 per cent and 26 per cent respectively compared to the ones done in 2024.

Many listed BDCs are trading at discount to NAVs. Are they reflecting concerns that default rates can spike?

There are many factors that contribute to difference between price and valuation. Professor Damodaran cites reasons like mood and momentum, liquidity and trading ease, incremental information and group think as drivers of price. The current negative sentiment around private credit and macro views also influence price. Then there is the AI threat, which is real but nuanced and hard to quantify and that uncertainty is also priced by the market.

Finally, can you explain why you are of the view that this is not 2008 crisis redux?

In direct lending, loans are extended to companies with business and growth trajectories having already demonstrated revenue and cash flows.

The GPs diligence these entities before underwriting them. They hold them in the funds they manage through the duration of the loan; essentially, the funds are buy and hold investors. These entities have financial audits and further, companies in the core and lower middle market also have financial maintenance covenants in their credit agreement as a sign of early warning. The funding is also well diversified across sectors and industries in most of the vehicles GPs manage.

The 2007-08 crisis, on the other hand, was due to loans to one asset class — residential home loans. The loans were to borrowers, many of whom would not have qualified but possibly did so in anticipation of rising home prices, which would imply an increase in home equity to justify the loans. Further, these loans were originated and sold to be securitised and re-securitised; the incentives were not aligned creating a bit of an agency issue.

Bank lending to private credit is limited, and banks are also sufficiently over-collateralised. Our view is that while credit headwinds exist, we do not see evidence of a broader spillage of this into financial system to trigger a systemic risk now.