Understanding Private Credit

Educational, not financial advice. This article explains how private credit works and how to check whether you are exposed to it. It is not a recommendation to buy or avoid any fund, and nothing here is tailored to your circumstances. Private credit is illiquid and can lose value. Figures verified 13 July 2026; market data moves, so check the primary sources linked at the bottom before acting on anything.

In 2024, one tenth of one percent of all US defined-contribution retirement assets sat in alternative investments (Department of Labor, proposed rule, 91 FR 16088). The Labor Department wants that number to go up. Its March 2026 proposal, written to implement an executive order, estimates that if it lands, roughly $178 billion and 4.5 million participants would flow each year into target-date funds that hold alternatives.

The largest alternative asset class by a distance is private credit. Which means the most likely way you will end up owning some is not a decision you make. It is a default option in your workplace pension.

So it is worth knowing what it is.

Key takeaways

• Private credit is a loan, not a share. A non-bank lender lends money directly to a company, on terms negotiated privately, and the loan never trades on an exchange. Your return is interest. You do not own a piece of the company.
• You may already be exposed through a pension scheme, a business development company (BDC) in your brokerage account, or an interval fund. The check takes about fifteen minutes and I've laid it out below.
• The extra yield is smaller than the pitch implies. The Federal Reserve found the spread over comparable syndicated loans had at points narrowed to below 200 basis points — while the lock-up stayed exactly as long.
• The real risk is not default. It's the exit. An interval fund is only obliged to buy back 5% of its shares per quarter. If everyone runs at once, getting half your money out takes about three and a half years. That arithmetic is below.
• Every major regulator has now published a warning — the IMF, the Bank for International Settlements, the Bank of England and the Financial Stability Board — and all of them use the same word: untested.

What a private-credit loan actually is

Strip out the jargon and it's a mortgage for a mid-sized company, arranged by someone who isn't a bank.

The Financial Stability Board — the body that coordinates financial regulators across the G20 — defines it as "nonbank direct lending to medium-sized companies negotiated on a bilateral basis" (FSB, Report on Vulnerabilities in Private Credit, 6 May 2026). Four features follow from that:

• It's bilateral. One lender (or a small club), one borrower, one negotiated contract. No prospectus, no public filing, no ratings agency required.
• It's floating-rate. The interest the borrower pays moves with benchmark rates. When rates rose after 2021, the coupons rose too — which is why the asset class looked wonderful for three years, and why the borrowers started struggling at the same time.
• It doesn't trade. There is no screen with a price on it. The value of the loan is whatever the fund's valuation committee says it is.
• The borrowers are mid-sized. The Federal Reserve puts the typical borrower at $10 million to $1 billion in annual revenue, and notes the average loan has exceeded $80 million since 2022.

Why every article gives you a different market size

Here is something the coverage almost never explains. You will see private credit described as a $1.5 trillion market, a $2 trillion market, and a $2.5 trillion market, in articles published the same week. None of them are lying. They are counting different things:

"Committed capital" is the gap. Investors promise money; the fund calls it down when it finds a deal. A headline market size that includes uncalled commitments is measuring the size of the ambition, not the size of the lending. Worth remembering the next time a fund's marketing deck shows you a hockey stick.

Why it grew — and the reason everyone gives you is the weakest one

The standard story is that Dodd-Frank and Basel III made lending expensive for banks, so the lending moved to funds. It's a tidy story. The BIS actually tested it.

Their March 2025 study decomposed the drivers across countries and found the dominant one was low interest rates: a one-standard-deviation fall in policy rates was associated with roughly 12% growth in private credit, as institutions chased yield. Weak banking-system efficiency explained more still. Stricter bank regulation contributed around 7% per standard deviation — real, but the smallest of the three (BIS Quarterly Review, March 2025).

So the honest summary is not "regulators pushed lending out of banks." It's "a decade of near-zero rates left pension funds and insurers desperate for yield, and an industry grew to sell it to them." That distinction matters, because it tells you what happens next. If the growth was a regulatory artefact, it's permanent. If it was a hunt for yield in a low-rate world, it is cyclical — and cyclical things mean-revert.

The premium is thinner than the sales pitch

You will read, in a lot of places, that private credit pays 200 to 600 basis points over comparable public debt. Treat that range with suspicion. The Federal Reserve's own analysis found the spread gap between private credit and syndicated leveraged loans had declined in recent years to below 200 basis points, before widening again after the 2023 rate hikes.

That compression is what you would expect. Capital flooded in. The BIS notes there is more committed money than there are good loans to make — and when supply of lending outruns demand for it, the price of lending falls. You are being paid less to accept the same illiquidity.

Six hundred basis points of extra yield would go a long way toward paying for a three-year lock-up. Under two hundred, before fees, is a different proposition entirely — and the fees on these vehicles start at 1.5% and go up from there. The spread is the whole case for the asset class, so it is the first number any fund selling you private credit should be made to show you: current, and net of what they charge.

What actually goes wrong

This is the section the fund brochures compress into one page of grey text. It deserves more room than everything above it.

When these loans default, you get less back

The Federal Reserve's estimate of post-default recovery on direct loans is around 33 cents on the dollar, against 52 cents for syndicated loans and 39 cents for high-yield bonds (Federal Reserve, February 2024). Private credit is usually sold as "senior secured," which sounds like it should recover more. It recovers less.

The reason is what it's secured on. The same Fed note found that more than half of all value-weighted private credit goes to borrowers in sectors with few tangible assets — software, financial services, healthcare. A senior claim over a software company's assets is a senior claim over some laptops and a codebase. There is no factory to sell.

The borrowers are thinner than they look

Interest coverage — earnings divided by interest owed — averaged around 2.0x for private credit borrowers, against 2.7x for syndicated leveraged loan borrowers (same Fed note). At 2.0x, a company earns two dollars for every dollar of interest it owes. That is not a crisis. It is also not much of a cushion if earnings fall by a third.

Payment-in-kind: the bit that should worry you most

A payment-in-kind (PIK) loan lets a borrower stop paying interest in cash and add it to the loan balance instead. The debt gets bigger; no cash changes hands; the fund still books the interest as income. Your statement shows a yield. No money has moved.

The FSB found PIK features in about 12% of private credit loans, with "PIK toggles" — an option the borrower can pull later — in roughly half of those. And it cites research showing that a borrower using a PIK toggle is associated with a 1 to 2 percentage point rise in the chance of that loan going delinquent the following quarter, against an unconditional probability of about 3% (FSB, May 2026). A near-doubling of the delinquency rate, signalled in advance, by a feature that makes the reported yield look fine.

If you hold a fund that reports its PIK income, look at it. If it doesn't report it, that is itself the finding.

Nobody knows what the loans are worth

Loans that don't trade have to be valued by a model. The FSB's language is careful and damning: valuations "are often conducted less frequently and may involve significant discretion, which can amplify uncertainty during times of stress," and — the sentence to remember — "perceived or actual stale valuations may create a first-mover incentive during stress events, leading investors to exit a fund before asset values are potentially marked down."

Read that as a consumer. If the marks are stale and the fund lets some people out, the people who leave first are paid a price that hasn't caught up with reality, and the people who stay absorb the difference. Smooth-looking returns are not the absence of volatility. They are volatility that has not been written down yet.

Leverage, layered

The fund that lends to leveraged companies is often itself borrowing. The SEC's own bulletin says that "under certain conditions BDCs may borrow up to $2 for every $1 of investor equity" (SEC Investor Bulletin: Publicly Traded BDCs). The BIS found average BDC debt-to-equity has climbed from around 0.4 to over 1.0 since 2011.

Here is the arithmetic, which you can redo on a napkin. Take a BDC at 1:1 — $100 of loans, funded by $50 of your equity and $50 of borrowed money. The loan book falls 10%, to $90. The debt is still $50. Your equity is now $40. A 10% fall in the loans is a 20% fall in your money. At the regulatory maximum of $2 borrowed per $1 of equity, the same 10% fall in loan values wipes out 30% of your equity.

Concentration

Private credit funds are far less diversified than banks. The BIS measured portfolio concentration (a Herfindahl-Hirschman index, where 1.0 is everything in one place) at an average of 0.74 for US funds, against 0.2 to 0.4 for banks in the syndicated loan market. Whatever "diversified private credit exposure" means in a marketing deck, it does not mean what it means in an index fund.

What the regulators are actually saying

The Bank of England's Financial Policy Committee lists the weaknesses in riskier credit markets, including private credit, as: "high leverage, weak underwriting standards, opacity, complex structures, and the degree of reliance on credit rating agencies" (Bank of England, Financial Stability Report, December 2025). The same report notes the 2025 failures of First Brands and Tricolor — both, in the Bank's words, with "complex and opaque funding arrangements" and high leverage "including through use of off-balance sheet debt."

And it makes a point almost nobody in the retail coverage has picked up: the sector most exposed to disruption by AI is software — which is also, in the Bank's words, "an area of high concentration in private credit and leveraged loan markets." At the same time, private credit is expected to finance a large slice of the AI infrastructure build-out. The asset class is lending heavily to the boom and lending heavily to the companies the boom may kill.

Now the counterweight, because leaving it out would be dishonest. The IMF's assessment was that "at present, the financial stability risks posed by private credit appear contained." The Federal Reserve looked at banks' lending to private credit vehicles — about $95 billion committed and $56 billion drawn as of Q4 2024 — and concluded the "financial stability implications seem limited" (Federal Reserve, May 2025).

So the regulators' base case is calm. Their caveat is uniform, and it is the FSB's: private credit "remains untested at its current size, scope, and concentration in a few economic sectors." Nobody is predicting a blow-up. Everybody is saying they cannot rule one out, because this thing has never been through a recession at this scale.

The liquidity arithmetic nobody shows you

This is the number that should decide whether you want any of this, and I have never seen it printed.

Interval funds are the main way ordinary investors are being sold private credit. They are open-ended in name only. The SEC's bulletin sets out the mechanics: repurchase offers "are generally made every three, six, or twelve months," the fund "will only buy back a certain percent — 5% to 25% — of all outstanding shares," if more shares are tendered than the fund offered to buy the repurchase "is generally done on a pro rata basis," and the fund may charge a fee of up to 2% (SEC Investor Bulletin: Interval Funds).

Run the pro-rata rule to its conclusion. Suppose the fund does the minimum — 5% per quarter — and suppose a stress hits and every holder tries to get out at once. Each quarter you get 5% of your remaining holding back. That's it. So:

The maths is one line: after n quarters you still hold 0.95ⁿ of your original stake. You can reproduce it in a spreadsheet in thirty seconds. Assumptions, stated plainly: the fund repurchases the 5% minimum, every holder tenders their whole position every quarter, the net asset value doesn't move, and no repurchase fee is charged. Real funds may offer more than 5%, and in calm markets you will almost certainly get your money on request. This is the stress case — and the stress case is the only case where liquidity matters.

It takes three and a half years to get half your money out. That is what the word illiquid means, and it is why "quarterly liquidity" on a fact sheet is one of the most misleading phrases in retail finance. Quarterly liquidity is an offer, capped, shared out pro rata, and revocable. It is not a redemption right. (If you want the plain-English version, we keep one in the glossary: what liquidity actually means.)

The traded version has the opposite problem

A publicly traded BDC solves this: you can sell it any day, on an exchange. But the price you get is not the net asset value — it's whatever the market will pay, and BDCs routinely trade at a discount to NAV precisely when everyone wants out. You have converted an exit queue into an exit price. One of those two costs is always being charged. There is no version of this asset class where the illiquidity is free.

And the fee is charged on the borrowed money too

One more thing hiding in plain sight in the SEC's bulletin. The BDC advisory fee is "generally equal to 1.5% – 2% of the fund's gross assets annually, plus certain incentive fees generally up to 20% of any profits."

Gross assets. Not your money — your money plus the leverage. At the BIS-observed average of roughly 1:1 debt-to-equity, gross assets are about twice equity, so a 1.5% fee on gross assets is about 3% a year on the money you actually put in — before the incentive fee. At the regulatory maximum of $2 borrowed per $1 of equity, gross assets are three times equity and the same 1.5% headline becomes roughly 4.5%. The fee is quoted against the biggest number in the structure. That is not an accident.

How to tell whether you already own any — a fifteen-minute check

Four places to look, in the order most likely to turn something up.

1. Your workplace pension or 401(k). Open the fact sheet for whatever fund your contributions default into — usually a target-date fund. Search it for the words private credit, private debt, alternatives, or direct lending. Today, most US plans will come up empty: alternatives were 0.1% of all DC plan assets in 2024. That is the number the March 2026 DOL proposal is designed to change, so re-run this check once a year.

2. A defined-benefit or public-sector pension. If you have one, you are almost certainly exposed and you have no say in it. The DOL's own proposal cites Cerulli data showing that in 2023, 24.3% of state and local defined-benefit assets were in alternatives. You are not the one bearing the mark-to-model risk in a DB scheme — your employer or the scheme is — but it is worth knowing it is there.

3. Your brokerage account. Look for three shapes:

• BDCs — business development companies. A legal category under the Investment Company Act; at least 70% of assets must be in qualifying (mostly private, mostly US) investments. They file with the SEC, so their entire loan book is public on EDGAR. If you own one, go and read the schedule of investments. It is the single most informative document available to any private-credit investor at any wealth level, and it is free.
• Interval funds and tender-offer funds — the repurchase mechanics above.
• Credit ETFs with a private sleeve. A handful of actively managed bond ETFs now hold some privately originated debt alongside public bonds. Daily liquidity on the wrapper; not on some of the contents. Read the holdings.

4. If you find something, read three lines of the prospectus and nothing else: the repurchase terms (how much, how often, pro rata?), the total expense ratio and whether the management fee is charged on gross or net assets, and the PIK income as a share of total investment income. Those three numbers tell you more than the entire performance section.

Where I come out

I would not go looking for private credit, and I would look hard at any target-date fund that starts adding it without asking me.

The case for it is real: the loans are senior, they're floating-rate, and for a genuinely long-horizon institution with no need for the cash, the illiquidity premium is a fair thing to harvest. Pension schemes have been doing it for years and they are not being stupid.

But the case gets weaker every step it moves toward an individual. You have a shorter horizon than a pension fund. You are more likely to need your money in a downturn — the same downturn in which the fund will be rationing exits. You pay a higher fee, often charged on leveraged assets. And the yield premium that was supposed to pay for all of this has been compressed by exactly the wall of money that is now being pointed at you.

The trade-off, stated flatly: you are accepting a multi-year lock-up, model-based pricing, and a fee that can run to 3% or more of your capital, in exchange for a spread over public credit that the Federal Reserve has measured at under 200 basis points. If you want corporate credit risk in a portfolio, you can buy it in a public high-yield or leveraged-loan fund for a few basis points, sell it any Tuesday, and see a real price every day. That is a worse yield and a much better deal for most people.

What would change my mind: a private credit fund that publishes its PIK income quarterly, charges its fee on net rather than gross assets, and prices its book against something other than its own model. When one exists, I'll write about it.

Frequently asked questions

What's the difference between private credit and private equity?

Private credit lends money and gets paid interest. Private equity buys ownership and gets paid if the company grows or is sold. Credit sits above equity in the queue — if the company fails, lenders are repaid first. That's the theory. The Fed's recovery data (33 cents on the dollar) is a reminder that "repaid first" and "repaid in full" are different sentences.

Is private credit safe?

No, and no one should tell you it is. It is a leveraged loan to a mid-sized company, held in a fund that may itself be leveraged, priced by a model, with restricted exits. Every one of those is a real risk. It is not a substitute for cash or for insured deposits.

Can I lose money in an interval fund even if none of the loans default?

Yes. Fees compound against you regardless. And if you need to exit during a stress, you may be forced to sell over several years at whatever marks apply then — or, in a traded BDC, at a market discount to net asset value. Neither of those requires a single borrower to miss a payment.

Are the 401(k) rules actually changing?

Not yet. The Department of Labor's proposal was published on 31 March 2026 and comments closed on 1 June 2026 (91 FR 16088). It is a proposed rule creating a process-based safe harbour for plan fiduciaries who add alternatives. Until a final rule appears, nothing has changed in your plan. Watch for it.

Why do private credit funds report such smooth returns?

Because the assets are marked by a model, not a market. The FSB warns explicitly that managers "may have potential incentives to manage valuations of their funds in a way that minimises the appearance of volatility." Smoothness is a property of the valuation method, not of the underlying loans.

Is private credit an inflation hedge because it's floating-rate?

Partly, and the sales pitch stops there. Rising rates lift the coupon you receive and the interest your borrower has to pay, out of earnings that are already covering interest only about twice over. The floating rate transfers inflation risk to you as credit risk. It doesn't delete it.

What should I watch for as a warning sign?

Rising PIK income as a share of total investment income; non-accrual loans creeping up; repurchase offers being pro-rated (that means more people wanted out than the fund would take); and traded BDCs slipping to a persistent discount to NAV. All four are public information. Most are quarterly.

Sources

• Financial Stability Board, Report on Vulnerabilities in Private Credit, 6 May 2026 — market size, PIK usage and delinquency, valuation practices, "untested."
• Federal Reserve Board, FEDS Notes, Private Credit: Characteristics and Risks, 23 February 2024 — recovery rates, interest coverage, spreads, borrower size, sector concentration, investor base.
• Federal Reserve Board, FEDS Notes, Bank Lending to Private Credit: Size, Characteristics, and Financial Stability Implications, 23 May 2025 — bank credit lines to private credit vehicles.
• Bank for International Settlements, The global drivers of private credit, BIS Quarterly Review, March 2025 — AUM, growth drivers, BDC leverage, portfolio concentration.
• Bank of England, Financial Stability Report, December 2025 — FPC assessment, First Brands and Tricolor, AI and software concentration.
• International Monetary Fund, Global Financial Stability Report, April 2024, Chapter 2: The Rise and Risks of Private Credit — market size including committed capital; vulnerability assessment.
• US Department of Labor, Employee Benefits Security Administration, Fiduciary Duties in Selecting Designated Investment Alternatives, proposed rule, 91 FR 16088, 31 March 2026 — DC plan alternatives data and projections.
• The White House, Executive Order 14330: Democratizing Access to Alternative Assets for 401(k) Investors, August 2025.
• US Securities and Exchange Commission, Investor Bulletin: Interval Funds — repurchase offer mechanics.
• US Securities and Exchange Commission, Investor Bulletin: Publicly Traded Business Development Companies — the 70% test, leverage limits, fees, distributions.
• US Securities and Exchange Commission, Investor Bulletin: Non-Publicly Traded BDCs — illiquidity and repurchase programmes.
• Federal Reserve Bank of Boston, Could the Growth of Private Credit Pose a Risk to Financial System Stability?, 2025.
• Further reading on this site: private credit, liquidity and ETF in the TheSchicht glossary.

Written by Muslih Abdiker Ali, founder and editor of TheSchicht. All figures were taken from the primary regulatory documents linked above and checked on 13 July 2026. The interval-fund and BDC leverage calculations are my own straight arithmetic from the SEC's stated rules; the assumptions are shown so you can reproduce or challenge them. AI tools were used in drafting; every claim, number and source in this article was verified by a named human, who is responsible for it.

Disclaimer: This article is for general education and is not financial, investment or tax advice. It does not take account of your circumstances. Private credit investments are illiquid, may be leveraged, are valued using models rather than market prices, and can lose value. Past returns tell you nothing about future ones. Consider taking regulated advice before investing in any illiquid or alternative asset.