Few asset classes have grown as fast or as quietly as private credit. From under $400B in 2014 to roughly $2 trillion today, the asset class has moved from alternative-investment curiosity to a core allocation in most institutional portfolios. The marketing case is well known: floating-rate exposure, double-digit yields, and a structural illiquidity premium. The harder questions — what happens when defaults rise, how marked-to-market would actually unfold, and how much of the growth is a true risk premium versus regulatory arbitrage — get less attention.

Why private credit grew

The simplest explanation is the most important one: banks retreated from middle-market lending after the Global Financial Crisis. Basel III capital rules made unsecured corporate lending punitively expensive in regulatory terms, while leveraged loan structures became commoditized through the broadly-syndicated market. The economic activity did not stop — middle-market companies still needed capital. Private credit filled the gap, and the GPs running the strategies could earn yields that no longer made sense for banks to capture.

This is, in our view, a structural shift rather than a bubble in the traditional sense. The borrowers exist. The demand is real. The competitive dynamics are not driven primarily by speculative fund flows.

But there is a but

What concerns us is not the existence of the asset class — it is the rate of growth in the past 36 months, the deterioration of covenants, and the layering of leverage.

On growth: the asset class has absorbed roughly $700B of new commitments in the past two years. Capital deployment at that pace forces GPs to either lower underwriting standards or wait — and waiting is hard when LPs are paying management fees on committed capital. Multiple data sources show the average leverage on new direct loans has crept from 4.5x EBITDA in 2021 to 6.0-6.5x today, with EBITDA itself increasingly defined with aggressive add-backs.

On covenants: "cov-lite" was supposed to be a syndicated-loan phenomenon. It has now migrated to direct lending. Estimates from rating agencies suggest more than 70% of new private credit issuance in 2025 carried materially weaker covenant packages than was standard three years ago.

On layered leverage: BDCs and CLOs holding private credit assets are themselves often financed with leverage. A first-loss tranche on a CLO that owns underlying loans at 6x EBITDA effectively sits behind 8-9x of total leverage when properly looked through. That structure is not unlike what existed in subprime mortgages prior to 2007 — not in a direct sense, but in the layering dynamic.

How a default cycle would actually unfold

The private credit asset class has not yet experienced a full default cycle. Returns since 2014 have benefited from low base rates (no recession-level defaults), generous mark-to-market practices (NAVs do not fluctuate the way liquid credit does), and a friendly regulatory environment.

In a real default cycle — say, defaults rising from 1.5% to 4-5% over 18 months — we would expect to see three things. First, NAV smoothing breaks down as GPs are forced to recognize losses they could previously defer. Second, secondary-market BDC discounts widen materially as listed BDCs face daily marking pressure that private vehicles do not. Third, distribution coverage ratios break, forcing dividend cuts that cascade into investor redemptions where redemption mechanisms exist.

None of this is necessarily catastrophic for the asset class. It is, however, very different from the smooth high-yield experience LPs have grown accustomed to.

Implementation views

Listed BDCs

Publicly-traded BDCs offer the cleanest expression of a private credit short, if one is so inclined. Premium-to-NAV pricing on the largest names embeds significant optimism about the underwriting cycle. We would not recommend an outright short, but a put spread on the BDC ETF (BIZD) is a thoughtful hedge for portfolios with broad credit beta.

Private allocation discipline

For LPs allocating to private credit at this point in the cycle, two disciplines matter. First, vintage diversification — committing the same dollar amount each year across vintages, rather than chasing 2024-2025 issuance. Second, manager dispersion — GPs with cycle-tested teams, conservative underwriting standards, and disciplined deployment pacing will dramatically outperform AUM-chasing peers when the cycle turns.

Public-market hedges

CCC-rated public credit and the lowest tranches of BSL CLOs are the cleanest macro hedges against a private-credit cycle turn. They will lead any move and offer better liquidity than attempting to hedge with private vehicles directly.

The bottom line

Private credit is not a bubble in the dot-com sense. It is a structural shift that has run ahead of itself in the past 36 months. The asset class will exist in five years and will likely still be larger than today. But the path between now and then includes a default cycle that has not been experienced, and the marks during that path will be uncomfortable for investors who underestimated the layered leverage embedded in their exposure. Respect, not enthusiasm, is the right posture.