Mercer: Private credit in perspective - noise, headwinds and opportunities
This article was originally written in Dutch. This is an English translation.
Markets are currently becoming increasingly concerned about private credit. Negative headlines, repayments and concerns about AI-related headwinds are putting pressure on exposure to software companies in both public and private markets.
By David Scopelliti, Global Head of Private Equity & Private Credit, Mercer
Recent market movements have prompted retail investors in particular to sell, leading to redemptions that exceed the usual 5% quarterly liquidity limit for which these funds were designed. The situation worsens when asset managers trigger the pre-set redemption gates. Given recent waves of redemptions by non-institutional investors, we are closely monitoring how managers will adjust their liability management, liquidity management and gating strategies. The good news is that, to date, all funds have fully met their promised quarterly liquidity targets, including, in some cases, honouring redemptions that exceeded the requirements.
We expect the negative headlines to persist as we enter a credit cycle characterised by ‘known unknowns’ and rising credit spreads. Investors are critically reassessing the sustainability and valuation of software companies, which constitute one of the largest sector exposures in many private equity-backed direct lending portfolios. Although the outcome remains uncertain, we are seeing a fundamental shift in how software risk is priced and underweighted in both public and private markets.
Despite these challenges, we believe private credit remains an attractive asset class. It delivers higher returns, has historically lower default rates and demonstrates resilience during market disruptions. The 12-month default rate in direct lending1 remains stable at 1.1%, compared to 4.2% for syndicated loans. The median year-on-year earnings growth of private market companies was 8.2%2 as of September 2025. To be successful as a manager in this market, it is necessary to possess the right expertise regarding: Although the climate remains challenging for some borrowers, it is essential for investors to actively respond to changing market dynamics and adapt to long-term trends.
- selecting high-quality companies;
- adhering to strict and consistent discipline in assessing, structuring and pricing loans, so that only creditworthy companies are financed on terms that adequately compensate for the risk;
- closely monitoring collateral;
- sound liquidity management.
BDCs and their role in private credit
Much recent coverage focuses on approximately 48 listed and 112 unlisted and private Business Development Companies (BDCs), which together represent approximately $482 billion in assets3. This is a part of the estimated more than $3 trillion sub-investment grade private credit market4. Public BDCs trade more like shares, with their prices not directly correlating with the underlying direct lending loans.
Correlation analyses show that the prices of public BDCs have a higher correlation with the S&P 500 (usually between 0.5 and 0.75) than with leveraged loans (less than 0.25 over 1–3 years, and 0.25 to 0.5 over 7–10 years). Direct lending BDCs represent only a portion of the broader private credit market, which, including structured credit, asset-backed finance/specialty finance and the substantial private investment-grade market, is estimated at approximately $40 trillion5.
Performance and quality of private credit
Private credit has consistently offered a significant premium relative to more liquid credit strategies. The Cliffwater Direct Lending Index measures the performance of US middle-market corporate loans and serves as a useful proxy due to its long history and broad coverage6. When examining performance from 1 January 2005 to 31 December 2025, we observe strong returns across various underlying periods, including crises, recessions and multiple credit microcycles.
All credit strategies experience defaults and losses. Private credit is not, by definition, riskier or less risky than public credit. However, it often benefits from structural protections, negotiated terms and bilateral cooperation during periods of stress. Lenders are often aligned with equity investors to preserve franchise value rather than seeking full ownership of companies.
At present, we do not see any systemic problems comparable to the global financial crisis. Most borrowers have demonstrated EBITDA growth and interest coverage ratios have improved. Stress is concentrated primarily in vulnerable sectors such as software.
Investors should factor in ongoing valuation volatility in software loans, which will affect short- and medium-term performance until it becomes clear which companies are failing and which are successfully deploying AI or technology.
The pricing of public BDCs suggests that current deviations between price and NAV are driven primarily by technical factors and sentiment, not by fundamental credit deterioration outside the software sector. Raymond James7 reports that the equity-weighted BDC group is trading at around 0.80x P/NAV, compared with a five-year average of 0.98x. Despite notable BDC redemptions and the ‘SaaS apocalypse’, trailing twelve-month defaults have remained relatively limited: 1.1% for direct lending, 4.2% for syndicated loans and 1.9% for high-yield bonds.
Looking ahead, KBRA forecasts a slight rise in direct lending defaults to 2.0% by 2026, with software loans slightly higher at 2.5%. These levels are in line with 2024 and do not represent an outlier. Default forecasts for syndicated loans and high-yield bonds suggest that liquidity and credit stress are not limited to private borrowers. Direct loans offer a significant spread premium relative to public counterparts, despite comparable or better credit quality, to compensate for potentially higher losses.
Beneath the surface, a number of high-profile fraud cases, late-cycle underwriting slippage and macroeconomic uncertainty are leading to greater divergence among private credit managers and stricter assessments of structures and liquidity. We view this as a healthy development for the market.
Private credit redemptions, liquidity management & gates
Liability management and access to multiple sources of liquidity are crucial when managing semi-liquid, evergreen and/or publicly traded vehicles. These behave significantly differently from closed-end credit funds. Following recent waves of selling in public and private vehicles, various approaches have been adopted for gating and liquidity management.
Non-tradable BDCs saw an increase in redemption requests. Some honoured sales, even above contractual gates, whilst others adhered to liquidity limits. Importantly, all funds have so far fully guaranteed their stated quarterly liquidity. Future wider application of gates could preserve the liquidity and financial flexibility of BDCs, but could also lead to reduced inflows or increased outflows.
Demand trends for private credit
Capital continues to flow into private credit primarily from institutional investors, despite a temporary decline in retail fundraising. New inflows into unlisted BDCs amounted to $43 billion in 2025, well above outflows and 23% higher than the $35 billion in 20248. New inflows into other private credit vehicles, across various strategies, amounted to $234 billion in 2025, virtually unchanged from the $241 billion recorded in 20249.
1. KBRA DLD Default Research TTM through February 16, 2026
2. Houlihan Lokey U.S. Private Credit Market Newsletter, October 2025
3. Houlihan Lokey Fall 2025 BDC Monitor
4. Estimate as at end of 2024. Sourced from Financing the Economy 2025 report by the Alternative Credit Council (ACC), the private credit arm of the Alternative Investment Management Association (AIMA)
5. Estimates from Apollo Global Management of the total private credit universe
6. The Cliffwater Direct Lending Index (CDLI) seeks to measure the unlevered, gross of fees performance of U.S. middle market corporate loans, as represented by the underlying assets of BDCs, including both exchange-traded and unlisted BDCs. The CDLI was launched on September 30, 2015, with performance history back to September 30, 2004, with asset coverage of over $42bn and over 17,000 loan holdings.
7. Raymond James, Business Development Company Weekly, published March 16, 2026.
8. Analysis from Robert A, Stanger & Company
9. Pitchbook 2025 Annual Global Private Market Fundraising Report
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SUMMARY Private credit remains an attractive asset class, offering higher returns and historically lower default rates than syndicated loans. Private credit plays a crucial role as a reliable source of capital for direct lending, asset-based and opportunistic strategies, and for serving high-grade borrowers with bespoke solutions. The coming period calls for careful credit selection, disciplined underwriting and robust management of liabilities and liquidity. |
Read the article in Financial Investigator magazine