Private credit’s compelling return profile — featuring lower defaults, reduced volatility, and superior yields compared to public credit markets — has driven substantial capital inflows over recent years. According to PitchBook, while overall private debt fundraising dipped slightly in 2024, it capped four consecutive years of annual capital raising above $200 billion. Direct lending funds, the sector’s dominant strategy, raised $120 billion globally last year, the second-highest total on record after 2021’s $143 billion peak. This growth has sparked questions about the sustainability of private credit’s performance advantages, particularly as massive capital pools now compete with broadly syndicated markets for constrained deal flow.
Renewed competition from traditional bank lenders on mega deals alongside lackluster M&A activity has compressed the juicy spreads private credit enjoyed in recent years. For one, sluggish private equity dealmaking and exits have left direct lenders struggling to deploy accumulated dry powder reserves. With excess capital chasing fewer investable opportunities, margins have narrowed across all direct lending segments. Lenders’ flight to defensive, service-oriented sectors to minimize exposure to tariff-sensitive business models has further tightened pricing.
Additionally, direct lenders face heightened competition not only among themselves, but equally from a reopened public credit market. Despite a brief freeze during the initial “Liberation Day” shocks, banks have regained their risk appetite over the past two years, eroding the pricing premium that private credit loans commanded in 2022 and 2023. According to LCD, 33.5% of business development company (BDC) portfolio holdings as of Q2 2025 priced below S+500, up from 17% a year ago, while investments priced at S+600 or higher fell to 24% from 44% last June. The shift marks a stark contrast to market pricing just two years ago, when average direct lending spreads hovered around 675 bps.
Meanwhile, as public credit markets offer tighter spreads, direct lenders also face refinancing headwinds as sponsors seek cost savings by moving loans to the broadly syndicated market. Through August 2025, two dozen issuers refinanced direct loans into BSL facilities, pulling roughly $24 billion from private credit portfolios, up from $19 billion at the same point last year.
In addition to placing downward pressure on pricing, enhanced competition has led private lenders to offer borrower-friendly terms to win deals. For example, payment-in-kind (PIK) options — which allow borrowers to add interest owed onto the loan’s principal in lieu of making cash payments — have become a sought-after differentiator in private financing.
Once the domain of distressed borrowers, healthy companies have utilized PIK toggles in recent years to prioritize growth initiatives while sustaining their leverage levels amid elevated interest rates and macroeconomic uncertainty. This flexibility has proved difficult to replicate in the broadly syndicated loan market, where many investors — including CLO funds — are bound by mandates requiring cash interest payments. In the best cases, the appeal of PIK is twofold: companies can preserve cash for value creation strategies, while lenders earn higher yields on deferred interest. However, these instruments are hardly risk-free.
Since PIK income is only realized at maturity or during refinancings, defaults amplify losses, as the anticipated “income” never materializes. If growth plans fail to deliver, stagnant or declining valuations combined with compounding PIK interest can trigger sharp spikes in loan-to-value ratios. As a result, sponsors may find their equity investments underwater, forcing additional capital injection. For lenders, repayment risk heightens as companies owe far more than what was originally borrowed.
Therefore, as PIK features proliferate across private credit, scrutiny has intensified surrounding their underlying rationale. Toggle PIK arrangements, as described above, are determined during origination and built into the original loan terms to align with strategic business plans from the outset. In contrast, PIK amendments, often denoted as “bad PIK,” are introduced through loan modifications later on and more often signal deteriorating credit quality as borrowers struggle to service their debt with cash. In these scenarios, PIK amendments function as a “shadow default rate” and have drawn criticism for keeping private credit default rates artificially low.
As companies continue to struggle under a strained economic backdrop, utilization of “bad” PIKbecomes increasingly important to understand. For example, as of August 2025, Lincoln International reported that PIK interest is present in 11% of all deals it values, with 53% of those deals exhibiting “bad” PIK characteristics. Among companies with “bad PIK,” the analysis revealed mounting distress, with average loan- to-value ratios surging from 45% at inception to 83% currently.
Ultimately, PIK income has a history of increasing during economic uncertainty, and recent years have been no exception. PIK income as a percentage of private credit returns has climbed, and while some contend that 7-8% of a 10-12% return remains a modest income component, the increase bears watching, particularly among larger lenders. For example, according to PitchBook, PIK interest income for the top 15 BDCs topped $1 billion in March 2025, reflecting a 20% year-over-year increase.
Intense market competition has pressured the covenant-heavy deal structures that have long defined private credit transactions. A decade ago, covenants were a fixture of private credit. Most loans typically carried at least one — often several — financial maintenance tests. Today, with competition fierce and deal flow thinner, the balance of power has shifted toward borrowers, who have pressed lenders into accepting weaker protections to win deals.
While covenant erosion has been limited at the smaller end of the market, it has become far more pronounced higher up the scale. In the upper-middle market — defined as companies with $50 million or more in EBITDA — around 30% of recent deals are now covenant-lite, up from just 5% a decade ago. The sharpest shift, however, is in mega- deals exceeding $500 million, where roughly half of new transactions lack financial maintenance covenants altogether. Private lenders vying with banks on hefty unitranche deals are increasingly swallowing covenant-lite terms.
The result has been a marked loosening of covenant protections across the landscape. Leverage-linked maintenance tests often now come with cushions that allow earnings to fall 30–40% before triggering a breach. Additionally, EBITDA definitions — padded with add-backs and forecasts — give borrowers ample performance leeway. Such inflated definitions can leave reported earnings looking healthier than reality, making leverage tests far less exacting. At the same time, borrowers have carved out sweeping exceptions to negative covenants, enabling them to add incremental debt or pay dividends with limited oversight.
Private credit has long attracted investors with its track record of significantly lower default rates compared to public credit. Some of this, of course, reflects the inherent advantages of private markets. Unlike the broadly syndicated loan market, private loans are not marked to market in real time when economic shocks occur. Further, the close relationship between lenders and borrowers enables private credit managers to work directly with companies during distressed periods, often restructuring deals before they reach technical default.
Public market investors simply cannot replicate this active hands-on management. However, as direct lending faces intensified competition and embraces borrower-friendly terms, questions have emerged about the asset class’s ability to maintain its historical default rates, especially in a “higher for longer” environment. For private credit, elevated interest rates present a double-edged sword. They boost returns while equally stressing borrowers who must service higher debt costs with potentially constrained cash flows.
The floating rate nature of these loans means many portfolio companies that borrowed when rates were near zero now face a much harsher economic reality. Nearly four years into this high-rate environment, certain balance sheets are feeling the pinch, as some companies struggle with muted earnings, tighter margins, and face base rates that are 350-500 basis points higher than when they were originally financed.
As a result, direct lending has exhibited an uptick in default activity in recent years as borrowers grapple with persistent macroeconomic pressures. However, signs of stress remain modest and contained within specific sectors and EBITDA profiles. For example, smaller firms record higher defaults than their larger counterparts that retain more operational levers and financing options to navigate difficulties. Yet, despite these pockets of pressure, widespread credit stress has not materialized across the broader market.
This resilience, however, has drawn scrutiny from industry critics who contend that prevailing default metrics present an artificially benign picture. These skeptics argue that traditional definitions of default overlook credit deterioration masked by loan amendments, maturity extensions, and questionable PIK conversions. A broader accounting, they argue, would reveal far higher levels of hidden stress. This debate highlights deeper questions about transparency and risk in a market that has expanded at an extraordinary pace over the past decade.
In a capital-saturated environment, origination capabilities take on heightened importance. Asset selection becomes even more critical, and success will hinge on those who can deploy capital resiliently. Access to differentiated deal flow, investment in high-quality borrowers with strong competitive moats, and sector-specific expertise to identify hidden risks will become essential differentiators. Beyond sourcing, alpha generation will increasingly depend on sophisticated loan structuring for downside protection and rigorous portfolio monitoring to track covenant compliance, borrower health, and stress-test scenarios across changing market conditions.
Here, Chronograph GP delivers next-generation portfolio monitoring solutions that consolidate expanding borrower portfolios into a centralized platform, while automating data ingestion, valuations, and reporting processes. Further, the flexibility of Chronograph’s data model directly addresses the key challenges facing the private credit sector today discussed here.
For example, as sponsors negotiate increasingly complex EBITDA definitions, credit teams can systematically capture all reported EBITDA versions from P&L statements to maintain independent risk assessments and cross-reference reported EBITDA in financials against compliance certificates. Additionally, with centralized data, lenders can enhance covenant monitoring by integrating financials into stress-testing models and deploying validation rules to track how close borrowers are to approaching breaches.
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