Private credit has quietly become one of the fastest-growing areas of the lending market, yet many investors are still unfamiliar with how it works. In this Client Question of the Month, we break down what private credit is, why it has grown so rapidly, and the potential benefits and risks investors should understand before considering an allocation. The goal is to provide clear context so readers can better assess where private credit may fit within a long-term investment strategy.

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Private credit, commonly referred to as direct lending, has progressed from a niche area of the lending market into a substantial component of the global financial system. Its significant growth is driven by changes in regulations and market conditions after the 2008 global financial crisis, positioning it as a rapidly expanding segment within alternative investments. To keep clients adequately informed, we outline what private credit is, its market evolution, and the potential benefits and risks it presents for long-term investors. It is important to note that private credit may not be appropriate for every investor; it’s best to consult your financial advisor to determine its suitability within your comprehensive financial plan and investment strategy.

What Is Private Credit?

Private credit refers to loans made by non‑bank institutions — such as private equity firms, alternative asset managers, private debt funds, or publicly traded business development companies (BDCs) — directly to companies (often small- to mid-size) that may lack access to traditional bank loans or public bond markets.

These loans are typically:

• Privately negotiated and customized, with terms often tailored to borrower needs.
• Illiquid, with limited or no active secondary market.
• Floating-rate, which reduces interest rate risk and provides protection in rising-rate environments.
• Secured, often backed by collateral or company assets.

How Private Credit Evolved: A 25-Year Story 

• Early 2000s — Bank-Led Direct Lending
  During the early 2000s, direct lending was present but represented a relatively small segment primarily controlled by banks. The documentation requirements were extensive, underwriting standards were conservative, and leverage levels remained restrained
• 2006–2007 — Private Equity Boom & Early Expansion
  The surge in private equity activity and liquidity led to more competition, prompting non-bank lenders to expand their presence in the space. This is when direct lending began to grow beyond traditional banking, giving borrowers quicker access to funds and greater flexibility in loan terms
• 2008–2009 — Global Financial Crisis (GFC)
  The GFC presented significant challenges for underwriting standards and loan documentation practices. In response, regulations such as Dodd-Frank and Basel III were introduced, requiring banks to hold more capital, maintain higher liquidity, and limit exposure to riskier borrowers. As a result, banks reduced lending to small- and mid-sized companies, creating a financing gap that private credit funds have stepped in to address.
• 2010–2021 — Post‑GFC, Regulatory Shift, and Growth of Private Credit
  Following the financial crisis, private credit funds were able to provide capital more efficiently and with greater flexibility than traditional banks, offering borrowers customized terms, quicker execution, and access to funding unavailable elsewhere. Additionally, years of low interest rates incentivized yield-seeking investors to allocate to private credit, further fueling its growth and competition.
• 2022–Today — A New Credit Cycle: Higher Rates, Stricter Conditions, More Dispersion
  The current environment is defined by higher interest rates, tighter liquidity, and wider dispersion in credit quality across borrowers. This dynamic combined with increased regulatory oversight is prompting banks to be more selective while private credit funds continue to gain market share.

Over the past 25 years, private credit has evolved from a relatively small, bank-driven lending option to a multi-trillion-dollar industry. The chart below illustrates this evolution from 2005 to 2024, showing the expansion in market size across high yield, senior loans, and private credit. Private credit has been the fastest-growing segment within the US Sub-Investment Grade credit market — expanding from roughly $70 billion in 2005 to more than $1 trillion in 2024 — and its share of the credit market has increased by nearly 20% over the 20-year period.

Private credit has participation from pensions, endowments, insurers, and wealth managers. To access this market, investors typically invest through private credit funds, which raise capital from institutional investors¹, accredited investors², and qualified purchasers³ and deploy it through direct originated loans rather than publicly traded debt or equity. This shift has led to semi-liquid fund structures that open private credit to retail investors, creating new opportunities and risks.

Potential Benefits for Investors

• Potential for Higher Income
  • Private debt generally offers higher income than public corporate bonds. These higher yields generally compensate investors for complexity, limited liquidity, and less transparency.

• Floating-Rate Loans
  • Many private loans have interest rates that reset periodically, which may help mitigate interest rate risk in rising-rate environments.

• Secured and Senior Positioning
  • Private credit (direct lending) strategies typically invest in senior level loans within a company’s capital structure, often secured by collateral and covenants that may provide additional protections in the event of bankruptcy.

• Lower Correlation to Public Markets
  • Private credit returns generally exhibit lower day-to-day volatility because loans are priced monthly rather than daily, providing additional diversification within a broader portfolio.
  • Valuations may be less sensitive to short-term market movements since private loans are not actively traded, potentially reducing mark-to-market volatility.

Key Drawbacks and Risks

• Limited Liquidity
  • Private credit funds often lock up capital for long periods — typically 5-10 years. However, evergreen funds for retail investors may have shorter lockups but access to capital early is still generally very limited, especially during economic downturns.
  • Moody’s highlights liquidity mismatches as retail-oriented vehicles (evergreen funds, interval funds, and private credit ETFs) promise more frequent liquidity despite holding inherently illiquid assets. In a stress scenario, large redemptions could pressure valuations or lead to asset sales — something the sector has not yet faced over a complete credit cycle.

• Use of Leverage
  • Many private credit funds use leverage to enhance returns. While effective in stable environments, leverage can magnify losses during stress periods and may limit liquidity.
  • According to Moody’s, increased lending by banks to private credit funds, BDCs, and specialty finance firms is creating tighter links between private credit and the traditional banking system. This could potentially amplify systemic stress if credit conditions worsen and defaults rise.

• Lack of Transparency and Valuation Risk
  • Private loans are negotiated directly between borrowers and lenders, with less disclosure compared to public markets. The valuations practices of these loans vary across managers and rely on estimates rather than observable market prices.
  • Because these loans are valued infrequently, marks may not reflect deteriorating credit conditions until a default occurs, and actual losses often only become apparent during periods of significant market stress.
  • The sector lacks standardized risk assessment tools and consistent reporting, which makes comparisons across managers or funds more challenging and highlights the need for thorough due diligence.

• Fees
  • Private credit funds typically charge higher fees than traditional fixed income investments. When combined with illiquidity, complexity, and manager dispersion, fees can materially impact net returns. This creates an even stronger need for rigorous manager due diligence.

• Economic and Credit risk
  • Private credit carries default risk similar to high-yield or distressed debt. Economic slowdowns, profit margin pressures, or high borrowing costs can challenge borrowers — particularly companies with high levels of leverage or cyclical business models.

• Manager Experience and Underwriting Quality
  • Moody’s notes that increased competition among lenders has led to looser underwriting standards and more borrower-friendly terms, which could increase the potential for losses in an economic downturn.
  • Many newer managers have limited track records across full credit cycles, making it harder to assess how they might perform during periods of elevated borrower defaults.

Conclusion

While private credit offers appealing characteristics, investors should be aware of certain risks — particularly given the rapid growth in recent years and the introduction of new loans and funds which require thorough evaluation. As the opportunity set expands and structures evolve, rigorous manager due diligence, thoughtful position sizing, and long-term planning become increasingly important. For clients considering an allocation, we believe private credit should be viewed as one component of a broader, diversified investment strategy that aligns with overall goals, liquidity needs, and risk tolerance. As always, consulting with your financial advisor can help determine whether private credit is appropriate within the context of your comprehensive financial plan.