Covenant Lite #11: Private Credit DEFAULTS!

Clouds on the horizon for private credit?

Welcome back to Covenant Lite! Today is going to be a bit of a shorter article, mostly because The Players Championship is on TV and I want to watch it…But don’t worry, I still have some interesting stuff for you.

For years, press coverage on private credit has been very positive, focusing on the insane growth of the asset class, its increasing adoption by institutional investors, its solid performance, its newly minted billionaires, etc. etc.

Skeptics of the asset class have cautioned that private credit is untested, having grown up in the ashes of the Great Financial Crisis of 2008/2009 and thus benefitted from a period of 15+ years of relative stability. While the asset class looks like it is here to stay, these critics say that they are withholding their laurels until such a test has taken place.

Well…it appears that such a test may be upon the private credit industry. Fitch and Proskauer report a material increase in defaults amongst private credit borrowers as of Q4 2024:

Obviously, there are fairly material differences between the three estimates, which have to do with inclusion methodology. The Fitch PMR (Privately Monitored Ratings) Default Rate reflects defaults among ~300 larger, sponsor-backed private credit borrowers monitored / rated by Fitch. The Fitch PCDR (Private Credit Default Rate) is a broader index covering ~1,200 middle-market borrowers tracked (but not necessarily rated) by Fitch. Finally, the Proskauer Default Rate tracks 800-900 loans that the law firm has advised on. All 3 calculate a default rate based on an issuer-count-based measure (as opposed to asset-weighted) for the trailing twelve months (“TTM”), so the Fitch PMR default rate meant that roughly 24 issuers of 300 issuers defaulted in the TTM to equal 8.1%.

The specific numbers here are less of the story than the trend, which is decidedly up and to the right. After years of low defaults across the board, it appears that dispersion in performance has finally hit the private credit space — similar to what we are seeing in US equities — as a result of the higher interest rate environment.

Facing this surge in distressed situations, private credit firms are expanding their restructuring and workout teams. Nonbank lenders historically relied on external advisors or bank syndicate leads to handle troubled loans, but now they are building in-house expertise.

The Wall Street Journal reports that direct lenders are paying a premium to recruit seasoned restructuring professionals – in some cases up to $1.5 million for mid- or senior-level hires – to navigate out-of-court workouts and bankruptcies (Link). These firms want dedicated staff who can proactively manage defaults, negotiate with borrowers and sponsors, and preserve value in their loan portfolios.

Recruiters have observed a significant uptick in demand for talent with distressed debt and turnaround experience over the past year. Private credit funds are especially seeking individuals skilled in “loan-to-own” strategies, operational turnarounds, and complex covenant negotiations. For example, Golub Capital – a major U.S. direct lender – has been hiring for its internal workout group (Link).

Talking with funds in the space, this reflects an industry-wide trend: many direct lending platforms (from middle-market specialists to mega-funds) have created or expanded special situations teams to handle troubled credits. These teams often include veterans of bankruptcy law, financial restructuring advisories, and even former private equity operating partners. The goal is to have the right skill set in-house to either restructure a loan amicably or, if needed, take control of a faltering borrower (as we’ve seen in some recent deals).

These trends mark a new phase for private credit as an asset class – from rapid expansion to a test of resilience. Lenders that can successfully navigate restructurings and workouts will be better positioned to protect investor capital and even find opportunities amid the turmoil. Those that cannot may face steep losses, especially if defaults continue to mount in 2025.