Banks aren't lending to small/medium-sized businesses like they used to. Small business commercial lending is down 17% year-over-year according to the Kansas City Fed's 2025 survey, the fifth consecutive quarter of decline. Regional banks are sitting on $957 billion in commercial real estate loans maturing this year and they're not exactly rushing to extend more credit.

So where's the money going? Private credit. And it's not some niche corner of finance anymore.

The private credit market hit $3 trillion in assets at the start of 2025, up from $2 trillion in 2020. Morgan Stanley projects it'll reach $5 trillion by 2029. That's a structural transformation of how companies access capital in America. But after several high-profile bankruptcies in late 2025 (First Brands, Tricolor) and Jamie Dimon warning about "cockroaches," everyone wants to know if this is an opportunity or a bubble waiting to pop?

Let me break down what private credit actually is, how it works, and why it matters to you as an investor - whether you ever put a dollar into it or not.

Private credit is just lending, but by non-bank institutions directly to companies. That's it. No bonds trading on public markets, no syndicated loans carved up between 20 different banks. Just Fund A lending $50 million to Company B in a privately negotiated deal.

Think of it this way. You're a mid-sized manufacturing company doing $200 million in annual revenue. You need $75 million to buy a competitor. In the old world (pre-2008), you'd call your bank. They'd spend six weeks underwriting the deal, form a syndicate with three other banks to spread the risk, and eventually fund you at prime rate plus 200 basis points with a bunch of conditions.

Today? That same bank tells you their commercial lending committee is "taking a cautious stance on M&A financing."

This is where firms like Apollo or Ares come on the scene instead. They act quickly - with some deals closing in a week or less, while the more complex deals require further due diligence but typically move much quicker than the traditional route. The catch here is that you're paying paying SOFR (The Secured Overnight Financing Rate) + 4-10% spreads. SOFR has become the primary floating rate benchmark for private credit, replacing LIBOR before it. In addition to higher rates the loan comes with stricter covenants (performance requirements), and if you miss your targets, they can step in and take control.

That's private credit in a nutshell. Quicker funding in exchange for higher cost and tighter oversight.

Here's where it gets interesting for investors. Private credit funds operate on a simple but powerful model.

Step 1: Raise Capital

Firms like Oaktree, Blackstone, or KKR go to institutional investors - think of CalPERS pension fund, Yale endowment, New York Life insurance company - and say: "Give us $1 billion. We'll lend it to middle-market companies and target 10-12% gross returns. You'll get 8-9% net after our fees."

Increasingly, they're also tapping wealthy individuals. If you're an accredited investor (generally $200K+ income or $1M+ net worth), you can access these funds through interval funds or private placements. There has been an explosion in wealth individuals demanding exposure to alternatives, and private credit has been a huge beneficiary of this trend.

Step 2: Originate Loans

The fund then sources deals. This happens three ways:

Step 3: Structure and Secure

This is crucial. These aren't unsecured loans like credit cards. Private credit is senior secured debt, meaning:

According to KKR's private credit team, their direct lending portfolio averages 45% loan-to-value. That means they're lending $45 against every $100 of company value, with the goal of providing a significant cushion before you lose money.

Step 4: Hold and Collect

Unlike hedge funds that trade in and out, private credit funds hold loans to maturity, typically 5-7 years. They collect interest quarterly (floating rate, so it adjusts with market rates), monitor the company's performance, and get repaid when the loan matures.

The floating-rate structure is critical right now. With SOFR (the benchmark rate) at 4.3%, a loan at SOFR + 400 basis points pays 8.3%. If rates rise to 5%, that same loan automatically adjusts to 9%. You've got built-in inflation protection but you also have to look more closely at the company’s ability to handle that kind of debt burden. This is a very rate-sensitive space, and many businesses of this size simply don’t have the margins to withstand higher interest payments.

Four massive forces converged to create this $3 trillion market.

Basel III capital requirements (which I become intimately involved with at Morgan Stanley monitoring the firm’s liquidity profile in my first year) fundamentally changed bank economics. After 2008, banks now have to hold significantly more capital against commercial loans, making traditional lending less profitable. A bank that could previously lend $1 billion holding $80 million in capital now needs to hold $120 million. That's $40 million they can't deploy elsewhere.

For big banks, corporate lending to Apple or Microsoft became more attractive than lending to mid-sized manufacturers. For regional banks, commercial real estate was their bread and butter, that is, until the maturity wall and office sector collapse made that toxic.

The lending void was enormous. Hundreds of billions in annual commercial credit demand with no willing bank lenders.

Private equity funds buy companies using debt. That's the model. In 2010, they could get bank financing for leveraged buyouts at 4-5x EBITDA (earnings). Banks pulled back after 2011, but private equity never stopped buying companies; they just needed a new lender.

Private credit funds stepped in offering 6-7x leverage. Higher than banks would provide, but at higher interest rates with stronger protections. According to Proskauer's 2026 private credit survey, maximum leverage ratios in new deals are running 6.0-6.5x EBITDA currently.

Every private equity deal now has a private credit component. It's a symbiotic deal that needs both to keep this ecosystem stabilized. PE needs the leverage, private credit needs the deal flow. Wealthy investors want options outside of the stock market and real estate. And everyone wants to make money.

Twenty years ago, a successful tech company went public at $500 million valuation after 5-7 years. Today companies like SpaceX and Stripe stay private past $50 billion valuations for 15 years.

These companies need capital but don't want the regulatory burden and quarterly earnings scrutiny of public markets. Private credit fills the gap with growth loans, acquisition financing, working capital facilities, and they do it all without forcing an IPO or opening the company up to rigorous oversight.

From 2010-2021, interest rates were near zero. Pension funds committed to paying retirees 7% annual returns couldn't get there with bonds yielding 2%. They needed alternatives. Private credit promised 8-10% returns with lower volatility than stocks. Insurance companies, which are naturally long-duration lenders, shifted hundreds of billions from corporate bonds into private credit to pick up 200-300 basis points of extra yield.

When the whole financial system is starving for yield, capital flows to wherever it's available. Private credit was the natural answer to this basic problem.

There is a temptation to view Private Credit lenders as smaller, with less sophistication and resources than Wall Street, but this isn't mom-and-pop lenders. It's institutional titans managing hundreds of billions.

Apollo Global Management: $200 billion in credit assets under management. They've been in distressed debt since the 1990s, evolved into private credit leaders. Recently partnered with BNP Paribas for a $5 billion direct lending vehicle.

Ares Management: Similar scale, with a heavy focus on direct lending to middle-market companies. One of the pioneers in Business Development Companies (BDCs) that let retail investors access private credit.

Blackstone: The largest alternative asset manager globally. Their private credit platform has grown from near-zero in 2015 to over $300 billion today through acquisitions and organic growth.

Oaktree Capital (majority-owned by Brookfield): Founded by Howard Marks and Bruce Karsh, the intellectual godfathers of private credit. $200 billion in credit strategies, known for disciplined underwriting.

KKR Credit: Manages $200+ billion, split between direct lending and asset-based finance. They're aggressive buyers of loan portfolios from banks looking to de-risk.

Carlyle, TPG, Neuberger Berman: All managing $50-100 billion in private credit across various strategies.

These are now 20-40 year old institutions with deep credit expertise, established deal flow, and hundreds of investment professionals. That matters when you're trusting someone with your capital in an illiquid investment.

You don't need $5 million to invest alongside an institutional investor. Three main paths exist for everyone:

These trade on major exchanges like regular stocks but invest in private credit. Think mutual fund structure applied to private lending.

Examples: Ares Capital (ARCC), Main Street Capital (MAIN), Hercules Capital (HTGC)

The appeal: Daily liquidity, quarterly dividends yielding 9-10%, diversified portfolios of 100+ loans, regulated by SEC (required to distribute 90% of income like a REIT).

The issue: They trade at market prices which can disconnect from NAV(Net Asset Value). During the March 2020 panic, ARCC dropped 55% even though underlying loan performance was fine. If you panic-sold, you locked in losses. If you held or bought, you did great, it's up 80% since then plus dividends.

These are private funds that offer quarterly liquidity (you can redeem 5% of assets per quarter). They invest in the same private credit deals as institutional funds but packaged for accredited investors.

Examples: Cliffwater Corporate Lending Fund, Ares Multi-Strategy Credit Fund, various Carlyle funds

The appeal: True institutional private credit exposure, higher yields (often 9-12% depending on strategy), less daily volatility because they don't mark-to-market.

The issue: Liquidity limits (quarterly redemptions capped at 5%), higher fees (1.5-2% management plus 10-20% performance fees), $25K-100K minimums, accredited investor requirements.

Some ETFs like PCRB (Invesco Private Credit) or closed-end funds provide exposure, though often indirectly through publicly traded private credit companies or structured products.

The appeal: Easier access, lower minimums, more liquidity.

The issue: You're getting exposure to companies that invest in private credit, not direct exposure. Performance can lag due to fund structure inefficiencies.

Let's be honest about what can go wrong, because plenty can. Most people I’ve talked to who are investing in BDCs or private credit investments don’t actually understand how they work, much less what the risks are that could sink the entire ship.

This is the big one. You're lending to companies that couldn't or wouldn't access traditional bank financing. Sometimes it's because they're growing fast and banks are slow. Sometimes it's because their balance sheets are already stretched. But these are not public, blue-chip businesses. Most of them have serious risk factors that emerge in a downturn or recession, especially in an economy that continues to bifurcate between the big guys and everyone else.

Default rates matter. The "headline" default rate in private credit sits around 1.5-2% annually right now. I know that sounds low. But that excludes distressed exchanges and liability management exercises where borrowers effectively default but avoid formal bankruptcy. Include those? The "true" default rate is likely closer to 4-5% when you take those failed deals into account.

The basic math is - if you're earning 9% yield but losing 5% to defaults with 50% recovery rates (you get back half your money), your net return drops to 6.5%. Still decent, but not the 9% you expected and in many cases just not worth that level of risk.

The biggest factor that gives me pause is that private credit hasn't been tested in a real recession yet. The entire modern market grew during a 16-year economic expansion (2009-2025, excluding the brief COVID blip). What happens when we hit a 2008-style downturn? Nobody knows for sure, and you can’t point to history for an exact comparison to fit this space.

Howard Marks, co-founder of Oaktree Capital, wrote in his November 2025 memo: "The tide has never gone out on private credit." We haven't seen the wreckage yet. It's going to come - the question is when and how bad. Only then will get a real look at how successful these firms have been in managing risk over the long-term.

Even the "liquid" options aren't that liquid. BDCs trade on exchanges, sure, but average daily volume on ARCC is only ~2 million shares ($40 million). Try selling a $5 million position quickly and you could actually move the price against yourself.

Interval funds are worse. Quarterly redemption windows capped at 5% of assets means if everyone wants out, you're waiting in line. Some funds can suspend redemptions entirely if market conditions deteriorate.

The number of clients I have seen in the past that were allocated in a non-redeemable REIT or BDC from a previous advisor, jumped at the chance to invest in it a year or two ago, and then are shocked to find that they can’t redeem it or re-allocate to another position in their portfolio, is simply staggering.

When you need the money and can't access it, the yield doesn't matter.

Private loans don't trade on exchanges, so there's no market price. Instead, managers "mark to model" - meaning they estimate what the loan is worth based on the company's performance and comparable market conditions.

This creates two problems:

Lagging recognition of losses: A company can be deteriorating for six months before the fund marks down the loan value. Public markets would have repriced it immediately. Private credit? It shows up quarters later in NAV.

Incentive conflicts: Fund managers collect fees on assets under management. They have an incentive to keep valuations high. While most are honest, the temptation exists - especially for newer, less established managers desperate to show returns. And we know how much damage that kind of temptation can do to fund managers (and markets as a whole).

Most private credit investments charge 1-2% annual management fees PLUS 10-20% performance fees (they keep 10-20% of returns above a certain hurdle).

Compare that to a high-yield bond ETF charging 0.40% annually with no performance fee. Over 10 years, that 2% annual fee difference compounds to at least a 20% drag on your returns.

You need the gross returns to justify the fees. If private credit delivers 9% gross and you pay 2.5% in total fees, you net 6.5%. High-yield bonds might deliver 7% gross with 0.4% fees, netting 6.6%. Suddenly the "premium" disappears.

If you're considering private credit exposure, here's what to monitor:

Corporate spending trends: Private credit depends on leveraged buyout activity and corporate M&A. If that slows due to recession, higher rates, or regulatory changes, then deployment opportunities dry up. Funds sitting on dry powder (undeployed capital) earn nothing.

Default trends by vintage: Loans made in 2021 are showing stress now. Those were peak valuations, loose underwriting, maximum leverage. Watch if this spreads to 2022-2023 deals. If it does, we've got a credit quality problem, not just isolated bad actors.

Spread compression: Private credit spreads have tightened from SOFR + 650 basis points in 2022 to SOFR + 400 now. That's competition driving down returns. If spreads compress further while credit quality stays constant (or worsens), the risk-reward tips unfavorable.

Bank re-entry into lending: If banks decide commercial lending is profitable again due to regulatory changes or improved economics, they could reclaim market share. Private credit premiums would compress significantly.

Private credit isn't going away. It's a structural shift driven by bank retreat, private equity's need for leverage, and companies avoiding public markets. The $3 trillion market today becomes $5 trillion by 2029 because the underlying demand is real and growing.

But understanding something doesn't mean you need to own it. Private credit makes sense for investors who:

If you check those boxes, a 5-10% allocation to quality BDCs or established interval funds can add diversification and income to a portfolio. Start small. Learn how they perform through different market conditions. Scale up only if it proves itself.

If you're not comfortable with the complexity, illiquidity, or credit risk? That's fine. There are simpler ways to generate income. High-quality corporate bonds, dividend growth stocks, even just cash at 4.5% right now, all legitimate alternatives.

Private credit is filling a gap left by traditional lenders but it remains to be seen what happens to the space when recession hits and dominoes start to fall. The important question to ask yourself before you consider an allocation is whether you understand it well enough to make an informed investment, knowing what could come if it goes sideways.

The Earnout Investor provides analysis and research but DOES NOT provide individual financial advice. Jamie Dejter may have a position in some of the stocks mentioned. All content is for informational purposes only. The Earnout Investor is not a registered investment, legal, or tax advisor, or a broker/dealer. Trading any asset involves risk and could result in significant capital losses. Please, do your own research before acquiring stocks.