Investors are worried that unrecognized risks have accumulated in private credit, prompting some to pull money from the market. But there are signs that private credit fundamentals remain strong, says Vivek Bantwal, global co-head of private credit in Goldman Sachs Asset Management.

“Private credit is certainly getting a lot of media attention right now, not all of it necessarily nuanced or accurate,” he says.

Data indicates that defaults and overdue loans in public and private credit continue to be at relatively low levels. Still, some managers have put out disclosures, seeking to allay concerns, and the information is reassuring, Bantwal says. They are showing double-digit growth in revenue and EBITDA (Earnings Before Interest, Taxes, Depreciation, and Amortization) by borrowers, increasing interest coverage, and improving margins.

How retail investors are affecting private credit markets

Part of what is occurring in private credit markets is more technical than fundamental, Bantwal says. Some retail investors are leaving the market, pulling back amid the reports about potential risks. As this happens, private credit may see higher yields relative to the risk-free rate, given how spreads have narrowed in recent years with increased retail investor money coming into the category.

Indeed, private credit grew rapidly as managers increasingly marketed new vehicles to affluent individual investors, broadening their traditional institutional investor base, Bantwal says. The thesis emphasized the potential for retail investors to benefit from an illiquidity premium (high returns from investments that aren’t as easily traded) relative to public fixed-income assets. Retail access centered on business development companies (BDCs) and other evergreen structures alongside the traditional closed-end drawdown funds long used by institutional investors.

Because these newer structures were often referred to as “semi-liquid” funds, some investors may have been left with an oversimplified understanding of how they work, according to Bantwal. These investments have always been for the illiquid part of a portfolio, he says.

Are defaults in private credit rising?

Bantwal does see some reasons to be cautious about private credit. “We have not seen a true credit cycle since the recovery from the Global Financial Crisis,” he says. The private credit industry has grown and matured in the ensuing 17 years. “There are a lot of new players in private credit that haven’t been tested through cycles.”

In addition, underwriting standards tend to deteriorate during extended benign periods, Bantwal says. This will create some risk and dispersion among lenders when the next downturn comes, but that risk exists across banks, public credit, and private credit.

Credit cycles are unlikely to end unless there’s a recession. Overall, the performance of borrowers in both public and private credit markets continues to be strong, Bantwal notes.

Is private credit vulnerable to disruption in software companies?

One of the worries percolating in private credit markets is the possibility that money managers have loaned too much money to software and technology companies vulnerable to disruption from artificial intelligence (AI). Software stocks have fallen sharply since February.

Many private credit managers do have significant exposure to software and technology companies, in some cases as much as 25% or 30% of their portfolios, Bantwal says. However, their lending is at the top of the capital structure and relatively insulated from restructuring.

Bantwal walk through a sample scenario in which credit was extended to a software company at six times debt-to-EBITDA. If the company initially was valued at 24 times EBITDA and has seen that valuation perhaps cut in half, there is still a significant cushion for the company to make good on the loan. In other words, the senior lending position provides protection.

What’s going to be important is the underwriting, Bantwal says. “Because not all software is created equal.” Software companies with business models that have control over proprietary data, long-standing customer relationships, or a mission-critical role will be more resilient in the face of AI disruption. Some other companies may struggle and see their valuations fall enough that their private credit loans become more tenuous.

Bantwal concludes that this dynamic is likely to increase the dispersion in the performance of private credit portfolios—widening the range of outcomes between the best and worst funds.

Is private credit a systemic risk to the financial system?

Any potential risks that the private credit markets may pose to the financial system as a whole are muted for several reasons, he says. Systemic risk in prior periods such as the Global Financial Crisis featured concentration, interconnectedness, high leverage, and asset-liability mismatch.

Bantwal doesn’t see these potential systemic concerns today in private credit. Rather than being concentrated, the $1.5 trillion to $2 trillion in the private credit market is spread across many thousands of stakeholders with limited interconnection, he says. Leverage in private credit vehicles is about one-to-one. And assets and liabilities are well-matched because closed-end private credit funds, and even the BDC structure, prevent or limit rapid investor withdrawals.

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