The era of easy money ended years ago. The consequences are only now becoming visible. Private credit, once the untouchable darling of institutional portfolios, is cracking. The numbers do not lie. Lenders are no longer just collecting interest. They are managing crises.
Yesterday, Goldman Sachs released a briefing featuring Howard Marks of Oaktree Capital and Michael Arougheti of Ares Management. The tone was not celebratory. It was defensive. For years, these titans argued that private credit was safer than public markets because of tighter covenants and direct relationships. That narrative is being tested by a reality of sustained high interest rates and eroding corporate margins.
The Mirage of Low Default Rates
Official default rates in private credit remain deceptively low. This is a mathematical illusion. Unlike public bonds traded on the Bloomberg Terminal, private loans are marked to model. If a borrower cannot pay, the lender has tools to hide the pain. The most popular tool is the Payment-in-Kind (PIK) toggle. Instead of paying cash interest, the borrower adds the interest to the principal balance. The lender avoids reporting a default. The borrower avoids immediate bankruptcy. The problem simply grows larger.
The technical term for this is evergreening. It is a desperate maneuver. Recent data suggests that PIK usage has surged to levels not seen since the 2008 financial crisis. When interest coverage ratios drop below 1.0x, the PIK toggle is the only thing keeping the lights on. But you cannot pay employees or suppliers with PIK notes. Eventually, the cash runs out.
The Ares and Oaktree Divergence
Michael Arougheti of Ares Management has long championed the scale of the asset class. He argues that the shift from banks to private lenders is structural and permanent. This is likely true. However, structural shifts do not guarantee returns. According to recent filings tracked by Reuters, the spread between top-tier and bottom-tier private credit funds is widening at an alarming rate. The winners are those who stayed disciplined. The losers are those who chased yield in the tech-heavy software as a service (SaaS) sector during the 2021 frenzy.
Howard Marks of Oaktree Capital remains the industry’s conscience. His recent memos have warned of a sea change where the tailwinds of falling rates have turned into permanent headwinds. Marks is focused on risk control. He knows that in a high-rate environment, the seniority of a loan in the capital stack is irrelevant if the enterprise value of the company has collapsed. Many private equity sponsors are now handing the keys of their portfolio companies back to the lenders. The lenders, who are supposed to be asset managers, are suddenly finding themselves in the business of running car washes and software firms.
Visualizing the Pressure Points
The following data represents the shift in how private credit portfolios are structured as of mid-May 2026. The rise in PIK usage is the most significant indicator of underlying stress in the mid-market sector.
Regulatory Shadows and Disclosure Gaps
The SEC is no longer watching from the sidelines. New transparency requirements for private fund advisors are forcing a level of disclosure that many in the industry find uncomfortable. The SEC’s latest focus is on the valuation methodologies used by private credit funds. If a fund marks a loan at 98 cents on the dollar while the borrower is using a PIK toggle to survive, the SEC sees a discrepancy. This is not just a matter of accounting. It is a matter of investor protection.
Retail investors are now being funneled into these products through non-traded Business Development Companies (BDCs). These vehicles offer higher yields than savings accounts but come with significantly higher risk. The liquidity mismatch is a powder keg. Investors expect to be able to withdraw their money monthly or quarterly. But the underlying assets are illiquid loans to struggling companies. If a wave of redemptions hits, the gates will come down. We have seen this movie before. It never ends well for the latecomers.
The Liquidity Trap
Dry powder is the industry’s favorite defense. Proponents point to the hundreds of billions of dollars in uncalled capital waiting to be deployed. They claim this will provide a floor for valuations. This logic is flawed. Dry powder is not a charity. It is profit-seeking capital. It will not be used to bail out failing loans made in 2021. It will be used to buy the distressed remains of those companies at cents on the dollar. The existence of dry powder is actually a threat to current portfolio valuations. It represents the competition that will eventually price the market to reality.
The pressure is most acute in the middle market. These are companies with EBITDA between 25 million and 75 million dollars. They do not have access to the public bond markets. They are entirely dependent on their private credit providers. As interest costs have doubled or tripled, their ability to invest in growth has vanished. They are in survival mode. This stagnation will eventually bleed into the broader economy, impacting employment and capital expenditure across the industrial and service sectors.
Watch the June 15 deadline for the next round of Form PF filings. This data will provide the first comprehensive look at how many funds are currently utilizing emergency liquidity facilities to meet redemption requests. If the PIK usage trend continues its vertical climb, the scrutiny mentioned by Goldman Sachs will turn into an all-out retreat. The next milestone is the third-quarter valuation reset. That is when the models must finally meet the market.
