The boom in private credit over the past decade has taken this asset class from a sideshow in an obscure corner in financial markets into an estimated $1.5 to $2 trillion headline act, with private credit funds, global asset managers and investment banks all vying for a slice of this lucrative pie. The investment premise was always based on superior risk-adjusted returns, low volatility, rigorous due diligence and watertight structures with the protections of real collateral and a comprehensive covenant package.
The private market has ballooned in recent years. Competition has flared, and as a result, credit spreads have narrowed compared to those in the public high-yield bond market. Meanwhile, retail investors have been drawn into this illiquid, opaque market. Alarms are now ringing as defaults climb (the Chair of Partners Group warns they could double) amid recent bankruptcies, fraud allegations and investor withdrawals from some of the world’s largest investment funds such as Blackstone and BlackRock. This would suggest that underwriting discipline has faltered and risk monitoring has been sub-standard.
We ask the questions: Have the core principles, or five Cs, of credit management been applied as rigorously as everyone assumed, and how can these risks be mitigated?
- Character
The recent collapse of UK-based mortgage financier, Market Financial Solutions (MFS), followed hot on the heels of auto parts supplier First Brands and subprime auto lender Tricolor in the US—all three amid allegations of fraud. While complex structures are not uncommon in private credit, alarm bells should ring when the convoluted web of borrowing structures and opaque legal entities appears to have been designed to cloak financial deceit. Careful due diligence during loan underwriting should flag when the key stakeholder has a checkered past, as alleged in the case of the First Brands CEO. Likewise, in the case of MFS, whose founder had ballooned the balance sheet across a myriad of entities to disproportionate levels, including loans to a corrupt Bangladeshi politician and a UK entity with alleged links to organised crime. All while appointing a local high-street accountancy firm based in the sleepy backwaters of North London, with interconnected interests to its client.
Most concerning of all is the allegation from creditors of so-called “double pledging,” the dark art of pledging the same assets as collateral to multiple lenders. More on this particular “C” below, but technology can be used to complement the work undertaken by the lawyers and bankers during a digitized loan origination process, from mapping out a full corporate structure, to flagging suspect behavior by borrowers, to cross-referencing collateral or even fraud detection using AI tools.
- Capacity
When borrowers do not have the capacity to service their debt in cash, the private credit market has increasingly turned to payment-in-kind (PIK) arrangements, effectively rolling interest into the loan balance rather than collecting it. Publicly-listed private vehicles are now receiving roughly 8% of investment income via PIK, and net leverage ratios among developed market (DM) private deals have increased to 5.5X in recent years. Covenants, which provide the financial metric safeguards against a debt binge or weak interest coverage, have become lighter and less onerous upon borrowers. These are worrying trends pointing towards unsustainability, weaker oversight and credit deterioration. Therefore, cashflow modeling, covenant monitoring, real-time data integration, early warning systems and dynamic dashboards all play a critical role in proactive risk monitoring.
- Collateral
Collateral, or lack thereof, has been the most adverse outcome of recent cases such as MFS, where potential fraud via real estate asset “double pledging” against loans has unearthed a possible £1.3bn shortfall, leaving major Wall Street players exposed. Best practice for credit mitigation demands that collateral (for example, security such as real estate or other hard assets) is not only taken and linked to borrowing facilities, but is also independently verified, continuously monitored, cross-checked against public registries and regularly valued. Comprehensive collateral management systems that are embedded within loan management systems and integrated externally with authoritative data sources are no longer luxury infrastructure—they are the first line of defense. This ensures prompt enforceability and higher recovery values in a default scenario.
- Conditions
The private credit asset class has, in recent years, enjoyed relatively benign economic conditions, booming stock markets and abundant liquidity. For an illiquid asset class, the latter has proven to be a double-edged sword, as the competition among asset managers and banks opened the private credit market to retail investors who, by nature, demand some degree of liquidity. The recent market conditions have changed the risk landscape as geopolitical crises, commodity shocks and interest rate volatility, together with a hangover for the AI story in sectors such as software, have caused blind panic and a dash for cash. This outflow has led to forced selling among high-profile asset managers for an illiquid product that is designed to be held to maturity. Therefore, risk frameworks need to adapt to the new reality, embedding scenario analysis and macro stress testing into credit risk workflows, along with covenant and collateral monitoring at a micro level.
- Capital
The underwriting process often involves factoring in the borrower’s stated capital position. Understanding a counterparty’s true net worth and equity in the business, as well as any other assets, builds a clearer picture of the protections—or risks—associated with a lending decision. Systems that can evaluate the credibility of personal guarantees or risk transfers form another layer of credit risk mitigation. Automated valuation tools, third-party data enrichment and regular portfolio monitoring processes form key components in the risk infrastructure.
The Broader Lesson
The mandate is therefore clear: private credit investors must invest seriously in the data, systems and processes that bring the Five Cs to life in real time, from digital origination platforms that flag borrower behavior, to collateral management systems integrated with public registries, to macro stress-testing frameworks and early warning systems that reflect today's volatile world rather than yesterday's benign conditions. This is not a nice-to-have, but an imperative for protecting investments and ensuring responsible growth.