Private credit is in the bubble of all bubbles

There’s been a massive influx of capital that needs to be deployed, and that pressure is leading to weaker underwriting in parts of the market.

But there’s a risk I’m not seeing discussed nearly enough:

Synthetic PIK structures.

PIKing is usually a red flag, it often reflects underlying cash flow stress. Everyone knows that, which is why managers try not to show it.

Enter synthetic PIK.

By setting up a separate financing vehicle to provide incremental funding, often outside the main fund and not fully disclosed to LPs, managers can understate the true level of PIK exposure in the portfolio.

If that sounds familiar, it should.

Off-balance-sheet financing has been a common feature of nearly every major financial blow-up (Enron being the canonical example).

That said, the broader data paints a more balanced picture than the doom headlines suggest:

• Default rates are 20–30% lower than in 2023–2024
• Average LTVs are meaningfully lower than pre-GFC levels
• Private credit is earning roughly ~200 bps of excess spread over leveraged loans today #farmtotable
• The asset class has shown durability through prior stress periods (GFC, pandemic, regional banking crisis)

So this isn’t a call to avoid private credit.

It is a call to be far more discerning about who you partner with when funny business like synthetic PIK starts to creep in.

And it’s also worth remembering:

Corporate direct lending isn’t the entire private credit universe.

There’s a large and growing opportunity set in asset-based lending (ABL) that should only expand over the next decade, with very different risk dynamics than sponsor-driven unitranche loans.