Private credit in a new refinancing environment

Key takeaways

• Liquidity headlines often reflect structural features of fund vehicles rather than automatic credit impairment.
• Companies that borrowed or refinanced in 2021 and 2022 at exceptionally low rates now face refinancing in a materially higher-rate environment.
• Conditions remain constructive in aggregate, but underwriting outcomes are becoming increasingly dispersed by sponsor quality, sector, and capital structure.
• In this phase of the cycle, disciplined leverage, structural diversification, and prudent liquidity management are likely to command a premium.

Recent market commentary has highlighted liquidity pressures, particularly rising redemption requests across several large Business Development Companies (BDCs) and other semi-liquid vehicles, prompting increased scrutiny of the asset class.

The broader reality, however, is more nuanced. Private credit is entering a new phase of the cycle shaped by refinancing dynamics, liquidity design, and widening dispersion across managers and strategies. In this environment, outcomes are likely to reward disciplined underwriting, resilient portfolio construction and managers capable of navigating a more difficult refinancing world.

Private credit has always been cyclical. What distinguishes this phase is the starting point. Pandemic-era rates allowed companies to borrow at exceptionally low costs, often with more aggressive capital structures. Some were refinanced amid continued strong demand for private credit, extending maturities. Today, inflation and higher base rates have reset the environment and many of these organizations that had been hoping the rate environment would revert need to refinance again under materially different conditions.

A meaningful portion of some portfolios was built in 2021 and 2022, when capital was inexpensive and valuation multiples were elevated, as significant inflows into retail funds required immediate deployment. That context matters as those vintages approach refinancing in a higher-rate regime.

Private credit that was not refinanced is now doing so in a materially higher rate environment, with floating-rate coupons having already reduced free cash flow. Because maturities typically fall five to seven years from origination – and sponsors rarely wait until the final year to refinance – refinancing shifts from optional to necessary, and at a time when capital is becoming scarcer due to fund flows.

Even against this backdrop, corporate fundamentals remain constructive in aggregate and income generation remains attractive. In more challenging credit environments, defaults typically affect a minority of borrowers. Uncertainty around which borrowers may face stress can materially tighten credit conditions and widen spreads as capital flows slow.

Lower-quality, highly levered borrowers with near-term maturities are likely to feel pressure first. As prevailing yields make refinancing more expensive – and in some cases uneconomic – amendment activity and liability management are increasing. Some transactions may resemble refinancings that delay immediate pressure but, in practice, reflect complex intercreditor dynamics as lenders seek to protect their positions in a potential restructuring or bankruptcy filing.

This dynamic can represent a structural advantage of private lending, as defaults may be addressed over time rather than through simultaneous liquidations during a broad downturn, typically the most challenging environment for recoveries.  Instead of a sharp dislocation, the adjustment is more likely to unfold as a gradual reset of capital structures: negotiated restructurings, maturity extensions, repricing of risk, and incremental equity support.

As refinancing shifts from optional to necessary, more sponsors may reassess the prospects for a profitable exit on certain deals originated before the move to significantly higher rates. That is why we have typically favored GPs with disciplined underwriting and operational expertise; helping businesses recover and maximize outcomes during difficult periods is when quality private credit managers truly separate themselves.

Recent coverage of private credit has been largely negative, particularly around liquidity concerns. However, while those issues deserve scrutiny, most have limited relevance for the majority of investors.

On stock performance, many publicly traded private credit managers have seen their share prices decline meaningfully. That reflects a re-rating of asset management businesses following a period of rapid growth and elevated margins, rather than an automatic read-through to underlying portfolio performance.

Similarly, liquidity headlines are more nuanced and often center on redemption activity in semi-liquid vehicles. Many investors were drawn to private credit with what felt like a promise of liquidity, and that liquidity is now being tested. Most open-end funds disclose quarterly redemption limits, yet it can still come as a surprise when those limits are reached. While gating may be disappointing, it does not automatically imply credit impairment.

The more consequential issue is how credit managers respond. Redemption limits are designed to protect investors from the structural mismatch between private assets and periodic withdrawals at net asset value (NAV). Accommodating redemptions beyond required thresholds may provide short-term flexibility, but it can introduce longer-term portfolio consequences.

Selling assets to meet redemptions is where those trade-offs become more tangible. Private credit’s structural advantage has long been single-lender control, which can simplify negotiations in stressed situations. Selling down positions or clubbing transactions may dilute that control. Selling materially below valuation marks can crystallize losses and reshape portfolio composition.  Even transactions executed near marks may alter the concentration and risk profile of what remains.

Real market stress reveals differences in credit selection and portfolio construction. When capital is easy, those differences are less visible. When refinancing is no longer automatic, outcomes are more likely to diverge. We see three key areas that differentiate private credit managers in the current environment. 

1. Selectivity

Strong businesses with durable cash flow and engaged sponsor support should remain relatively resilient. Over-levered credits are more likely to face restructuring pressure and increased liability management.

2. Deliberate portfolio construction

Diversification must be deliberate and focused on sources of cash flow and types of collateral – not simply the number of positions. A portfolio can hold many loans and still be exposed to the same economic driver. For example, a portfolio of 500 loans, 40% of which are U.S. private equity-owned software companies, is not meaningfully diversified. True diversification comes from exposure across distinct economic drivers, owners, collateral and capital structures, and providing flexibility when individual credits face stress.

3. Liquidity management

Liquidity management is increasingly central at this stage of the cycle. Operating close to leverage limits with minimal buffer may appear efficient in calm markets; however, it leaves limited room to maneuver when refinancing pressure builds or investor sentiment shifts. A modest sacrifice in yield, or the cost of maintaining unused line capacity, can be a reasonable price to preserve portfolio integrity without altering portfolio construction at the most inopportune time.

In a new refinancing environment, separating headline noise from structural change will be critical as access to private credit continues to expand across investor channels. Private credit is inherently illiquid, regardless of vehicle structure, and the return premium associated with the asset class reflects a long-term commitment of capital rather than tactical trading.

Private credit will likely continue to generate headlines as markets move through this phase of the cycle. Refinancing activity, liquidity design, and widening performance dispersion will shape the landscape across managers and strategies. In this environment, underwriting discipline, thoughtful portfolio construction and prudent liquidity management are likely to differentiate outcomes. For investors, separating structural realities from headline noise will remain essential.