US Private Credit: A Tempest in a Teapot or the Canary in the Financial System?

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The global private credit market, whose scale has surpassed $2.3 trillion, is undergoing a resonant test of multiple shocks.

Persistently high interest rates, frequent landmark bankruptcy events, the wave of AI reshaping software industry valuations, a tide of retail fund redemptions, and the heating up of Middle Eastern geopolitical tensions are converging into multiple pressures, pushing the US private credit market into the spotlight of public opinion. Its market fragility has significantly increased, and concerns about risk continue to rise. According to a February 2026 Merrill Lynch survey, 43% of fund managers have listed private credit as their most worrying source of credit risk.

Facing this situation, the latest report by Huatai Securities offers a cautious judgment: Private credit is currently in the “clearance phase” and short-term pressure will persist; but under the baseline scenario of a soft landing for the US economy in 2026, its systemic spillover risk to the financial system is generally controllable and more like a “storm in a teapot.” However, if the US economy falls into stagflation or the AI bubble bursts, the warning sent by this “canary” will be suddenly amplified.

From the investor perspective, current pressure is mainly concentrated in high-risk assets such as leveraged loans. While investment-grade credit spreads have widened somewhat, the overall magnitude remains limited and transmission to stocks and broader bond markets is still controllable. As the market moves deeper into the clearance phase, rising stagflation risks and increased volatility in the AI industry are becoming the two key tail risks determining the scale of this “storm.”

Four Major Vulnerabilities Behind the Boom: Risks Are Quietly Accumulating

The Huatai report pointed out that, alongside rapid expansion, the private credit market has also accumulated a series of structural vulnerabilities that cannot be ignored—involving borrower quality, valuation transparency, product design, and the ratings ecosystem.

From the underlying assets, borrower qualifications are generally weak. The median revenue of private credit borrowing companies is only $500 million, much lower than the $4.6 billion for leveraged loan issuers and $4.5 billion for high-yield bond issuers. As of Q1 2025, the average interest coverage ratio (ICR) of US private credit borrowers is about 2.1 times, significantly lower than the 3.9 times of public market companies; net leverage is 5.6 times, higher than the 4.6 times of public companies.

There is a lack of transparency in the valuation process. Due to the lack of continuous trading and observable secondary market quotes for private credit loans, valuations rely heavily on manager models and internal assumptions. The International Monetary Fund (IMF) has highlighted the issue of “stale valuations” in private credit—meaning that asset prices cannot timely reflect real risk changes.

In terms of product design, Pay-In-Kind (PIK) clauses are amplifying potential risks. The PIK mechanism allows borrowers to roll up interest due into principal, alleviating cash flow pressures in the short term but essentially postponing and amplifying risk. Currently, PIK usage in software industry BDC loans has risen above 20%, while “bad PIK”—where companies are forced to adopt PIK rather than pre-agree—has climbed from 36.7% in 2021 to 58.3% in Q2 2025, reflecting more companies falling into the predicament of “borrowing new to pay interest.”

The rating process is also distorted. As of end 2024, the US private credit market had $277.9 billion of “dry powder” funding that has been raised but not yet deployed—an increase of $181.7 billion over a decade, accounting for 20% of raised funding. Under the pressure to deploy funds, some institutions are found to “buy ratings” from private rating agencies. Data from the US National Association of Insurance Commissioners (NAIC) shows that private rating agencies’ ratings are on average 2.7 notches higher than NAIC’s independent assessments, meaning a substantial portion of asset risk may be systematically underestimated.

Fivefold Impact Combined: The Fuse for the Private Credit Market

Persistent high interest rates eroding debt service capabilities, landmark bankruptcies and frauds triggering crises of confidence, AI technology iteration-impact on software industry valuation, retailization trends leading to redemption tides, and elevated stagflation risk from Middle Eastern geopolitics—multiple pressures are exposing vulnerabilities in the private credit market one by one.

High interest rates are eroding debt service capabilities. Private credit commonly uses SOFR-based floating rate pricing, with spreads of 600 to 700 basis points over SOFR. Although the Fed has started the rate-cutting cycle, the federal funds rate will remain at a relatively high level of 3.5% to 3.75% by end 2025. The pressure on companies is already evident: Fitch’s Private Credit Default Rate (PCDR) reached 5.8% in January 2026, much higher than the 2%–4% platform in 2023–2024; US corporate earnings growth dropped from 12.8% in 2023 to -1.3% in 2025.

Landmark bankruptcies and fraud events trigger trust crisis. Between September and October 2025, First Brands and Tricolor successively entered bankruptcy proceedings. In the same period, Zions disclosed about $50 million in write-offs related to fraud, while Western Alliance chased nearly $100 million in loans and accused borrowers of fraud—both cases involving Cantor Group affiliated funds. In February 2026, UK real estate lender MFS collapsed due to alleged double pledging, with collateral for £1.16 billion in loans valued at only about £230 million, resulting in a potential gap of £930 million, involving Barclays, Santander, Wells Fargo, Jefferies, and Apollo’s Atlas and other institutions.

AI technology iteration impacts software industry valuation. Software services are the largest exposure in private credit. By Q4 2025, BDC's exposure to software services reached 20.2%. Since 2026, rapid AI development has led the market to reassess the profitability model for the software industry. JPMorgan has lowered valuations for some software loans held by private credit institutions and tightened financing conditions. Notably, the outstanding loans to AI-related industries in private credit rose from nearly zero in 2015 to over $200 billion in 2025, accounting for about 8% of outstanding private credit loans. The link between technological iteration and credit risk is deepening.

Retailization trend triggers redemption tide. The share of retail fund sources in private credit has risen from zero to 13%, corresponding to a scale of about $280 billion. The change in funding structure is putting liquidity pressure: US BDC average redemption rate reached 7.6% in Q1 2026, a sharp jump from 1.2% in Q2 2024. Blackstone’s $82 billion flagship private credit fund (BCRED) experienced a record 7.9% redemption demand in Q1 this year; Blue Owl permanently halted redemptions for its OBDC II fund and then sold its loan portfolio at a 99.7% discount; BlackRock’s HPS Fund's redemption demand also surged to 9.3%.

Middle East situation pushes up stagflation risks. Geopolitical factors are affecting the macro outlook channel via energy prices. If Brent crude prices average $80/barrel in 2026, global economic growth is expected to be dragged down by 0.1 –0.3 percentage points, global inflation pushed up by 0.5–0.6 points; if crude rises to $100/barrel, the drag would be 0.5–0.8 points and inflation pushed up 1.5–2.0 points, US inflation will return to over 3%. For the private credit market already in a high-rate environment, stagflation means a double squeeze of corporate earnings and financing costs.

Three Major Transmission Channels Assessment: Why It’s Still a "Teapot Storm"

Will risks in the private credit market spread to the broader financial system? The Huatai Securities report systematically assesses this core question from the perspectives of the banking channel, non-bank institutions channel, and market-price contagion. The conclusion shows: At present, risk transmission remains limited, but some weak links require ongoing attention.

Bank channel: limited exposure, controllable risk.

In terms of scale, banks' direct exposure to private credit is extremely limited. Federal Reserve research shows bank borrowing in private credit accounts for less than 1% of their total assets. In terms of asset quality, Kansas Fed research points out that banks’ default rates on private credit loans are only 0.2%, lower than 1% for commercial loans; loan recovery rate is 85%, higher than 82% for commercial loans. Boston Fed further notes that 96% of banks' BDC loans are first-lien secured, providing ample security cushion.

From an extreme scenario perspective, Fed stress tests show that even in a deep recession and a full credit and liquidity crisis among non-bank financial institutions, the primary capital adequacy ratio of the 22 large US banks can still remain at 13%, fully able to absorb losses. Recent mild increase in bank CDS also confirms limited market concern about risks spreading to the banking system.

Insurance and pension channel: low proportion, short-term impacts are controllable.

In total, as of 2024, private credit assets account for only about 3.5% of global pension and insurance company assets. Given the nature of funds, pension and insurance companies have long investment horizons, and unlikely to massively dump assets; most private credit funds use closed structures, eliminating immediate redemption and providing managers a buffer.

It is worth noting, however, that US life insurance companies have significant indirect links to private credit through BDC, JVLF, BSL, MM CLO and other structured tools; the penetrated credit risk and valuation fluctuations still require ongoing monitoring.

Market price contagion: has spread to leveraged loans, but not yet to broader markets.

Recent markets show early signs of risk transmission. US leveraged loan yields have risen significantly, once approaching the levels seen in April 2025 during tariff periods, partly due to market spillover concerns about private credit risks. So far, investment-grade credit spreads have widened slightly but remain within controllable range; the rise in VIX and MOVE indices is mostly driven by Middle Eastern geopolitical events, and private credit risk has not yet formed a systemic shock to equity and bond markets.

Tail Risks Cannot Be Ignored: Two Scenarios Could Change the Overall Assessment

Huatai Securities points out clearly that the current judgment of a “teapot storm” is built on the baseline scenario of a soft landing for the US economy. Should the macro outlook deviate from this track, two tail risk scenarios would significantly increase the chances of private credit developing into a systemic risk.

Scenario One: The US economy falls into stagflation. If ongoing Middle Eastern conflicts push up oil prices or trade policy turns more aggressive, the US may step into a stagflation regime where inflation rises and the economy falls. This would constrain the Fed’s room for rate cuts, further worsen corporate cash flows, making private credit already under pressure face greater strain, and potentially transmit risk to the broader financial system via banks, insurance, and market-price channels.

Scenario Two: AI bubble bursts. If the contribution of AI to economic growth falls sharply, private credit default rates will notably rise. Coupled with US stock declines and investment contraction, credit risk and economic downturn would interact negatively and amplify financial system fragility.

Overall, the clearing of the private credit market hasn’t finished yet and short-term pressures will continue. For investors, key signals to monitor now include: whether leveraged loan spreads widen further and spill into the investment-grade market, whether BDC redemption rates continue to climb, as well as the impact of Middle Eastern events and AI industry developments on the macro environment.

Under the baseline scenario, this storm may still be in the teapot—but the lid is being pushed up by increasing pressure.

Risk warning and disclaimerThe market carries risks, and investments should be made with caution. This article does not constitute personal investment advice, nor does it take into account the unique investment goals, financial situation or needs of any particular user. Users should consider whether any opinions, views or conclusions presented here suit their specific situation. Investing accordingly is at one’s own risk. ```