Private Credit Goes Mainstream… And Meets It’s First Stress Tests

Written By Theo Webb

Executive summary

Private credit has moved from a specialist institutional allocation into a mainstream component of corporate financing, with global assets commonly estimated around the USD 2 trillion mark by 2023—large enough to matter for macroeconomic outcomes, not just portfolio construction.

The macro relevance stems from two related shifts: (i) credit supply has partially migrated from regulated banks and transparent public markets into less transparent private markets; and (ii) the “investor base” is broadening, including via structures that promise periodic liquidity while holding fundamentally illiquid loans. These features can change the behaviour of credit availability through the cycle and the dynamics of stress.

Recent “stress tests” have been less about a single systemic crash and more about repeated, practical frictions: redemption pressures and gating in periodic-liquidity vehicles; contested or lagged valuation marks; and idiosyncratic credit events (including alleged collateral or receivables fraud) that highlight underwriting and monitoring challenges in parts of the market.

For allocators, the implication is not “avoid the asset class”, but “upgrade diligence to institutional standards”, especially around liquidity terms, valuation governance, leverage (including at multiple layers), conflicts of interest, and the mechanics of ongoing monitoring and escalation.

Assumptions used in this article: the reader is a family office (or equivalent long-horizon investor) evaluating either a commingled private credit fund or a managed account; the investor can obtain core fund documents and reasonably detailed reporting; and the investor’s constraints on liquidity, concentration, and tax or regulatory status are not pre-specified and must therefore be defined as part of the due-diligence process.

Why private credit is macro-relevant

A working definition from official research is that private credit is non-public, debt-like financing provided by non-bank entities—often via funds—through bilateral or “club” agreements rather than broadly traded securities. Historically focused on “middle-market” borrowers, it has expanded into larger transactions that would previously have sat in syndicated leveraged loans.

Market size and growth. Multiple official and multilateral analyses converge on the scale and pace of growth. One recent macroeconomic outlook characterised private credit as having reached roughly USD 2 trillion globally in 2023—equivalent to about 12% of bank loans to non-financial corporates in advanced economies, up from ~5% in 2012. A central bank bulletin similarly described global private credit AUM as having quadrupled over the prior decade to around USD 2.1 trillion in 2023, with a large share in North America and a meaningful share in Europe.

Growth drivers. The drivers are structural, not just cyclical:   

  • Bank intermediation constraints and substitution. Post-crisis banking reforms increased capital sensitivity and altered banks’ incentives, contributing to a migration of riskier corporate lending away from banks. More recently, policy adjustments to leveraged-lending guidance in the United States have been explicitly discussed as affecting where leveraged credit activity sits (bank vs non-bank) and how oversight is applied.     

  • Investor demand for yield and floating-rate exposure. Private credit is predominantly floating-rate and has been marketed as offering return potential and diversification characteristics relative to public credit, particularly in periods of changing rates.     

  • Borrower demand for speed and bespoke terms. Private credit is frequently negotiated directly, with tailored documentation and fewer lenders, which can be valuable to borrowers with complex needs.

Investor mix and the “retailisation” channel. While large institutions have historically dominated, recent official analysis flags a growing share of semi-liquid structures and increasing retail participation as a key vulnerability—because offering periodic liquidity against illiquid assets can create first-mover incentives and run dynamics. The growth of semi-liquid products has also been documented in market commentary, including rapid fundraising relative to traditional closed-end vehicles.

Role versus banks, and why that matters systemically. The macro impact is not only that private credit replaces some bank lending, but also that banks and private credit can become linked through financing lines and other forms of exposure. A 2025 official study using regulatory data found bank committed credit lines to private-credit vehicles rising sharply over five years, even if still small relative to banks’ exposures to the broader non-bank sector; it also highlighted the scenario of correlated drawdowns in stress.
At the system level, global monitoring work continues to emphasise that non-bank finance has grown to around half of global financial assets and that data limitations—particularly around defining and consistently identifying private credit activity—remain a constraint on risk assessment.

What recent stress events revealed

Private credit’s “first stress tests” at scale have been revealing because they surfaced frictions that are latent in the structure of the asset class: illiquid loans, limited secondary-market price discovery, and valuation processes that are judgement-heavy and typically less frequent than public markets.

Liquidity mismatches and redemption mechanics. Periodic-liquidity vehicles have provided concrete case studies. In late 2025 and early 2026, at least one large retail-facing private debt vehicle that offered quarterly liquidity used (and then revised) its redemption mechanics after sustained redemption requests—triggering sharp market attention to gating, queues, and the practical meaning of “quarterly liquidity” when assets are not readily saleable.
Separately, reporting in February 2026 highlighted how redemption limits (for example, quarterly redemption caps) can interact with higher aggregate request levels such that investors can effectively be locked out once pre-defined thresholds are hit—an illustration of how product design can create or mitigate “run-like” dynamics.

Valuation opacity and timing risk. Official analysis has repeatedly warned that stale valuations and infrequent mark-to-market practices can impede risk management and may create misaligned incentives when fees or fundraising depend on reported marks.
Regulatory reviews of private-market valuation practices have reinforced operational points that matter during stress: valuation governance must be robust and well documented; committee minutes must evidence genuine challenge; and functional independence (particularly separating valuation work from portfolio management influence) is central to credibility—especially where valuations are used to price subscriptions/redemptions or charge fees.

Fund-structure risks and hidden leverage. Stress periods tend to reveal where leverage is embedded: at the borrower level; inside fund-level facilities; and sometimes through off-balance-sheet or financing arrangements that change reported leverage at reporting dates. This connects directly to broader global policy work emphasising that leverage in non-bank finance can amplify stress and propagate shocks through interlinkages, and that monitoring frameworks and disclosures remain uneven.

Idiosyncratic credit events and underwriting verification. A series of specific credit incidents reported in 2025 (including alleged fraudulent collateral or receivables documentation in certain speciality-finance contexts) refocused attention on how private credit underwriting verifies collateral, cash flows, and documentation, and how monitoring detects early signs of misreporting or double-pledging risk.
The diligence implication is that “private” does not mean “unknowable”: rather, it shifts the burden of verification and controls onto the manager and the allocator, with outcomes highly sensitive to process quality.

Structural risks that matter most to institutional allocators

Private credit is not a single homogeneous product. Institutional diligence therefore focuses on structural risks that recur across strategies and fund wrappers—particularly where long-dated, illiquid assets meet near-term liquidity promises, judgement-based valuation, or layered leverage.

Liquidity risk and maturity transformation. Illiquid loans are inherently difficult to sell quickly without price concessions, and many private credit instruments lack an active secondary market. Liquidity risk rises materially when a vehicle allows periodic redemptions. In parts of the euro area, analysis found a sizeable share of private credit funds structured as open-ended, which can heighten liquidity mismatch risk depending on redemption frequency, lock-ups, and available liquidity management tools.
In response to liquidity-mismatch risk in open-ended funds more generally, international standards emphasise aligning redemption terms with asset liquidity and using liquidity management tools (LMTs), supported by rigorous stress testing.

Leverage at multiple layers. Even if a fund claims limited leverage, leverage can still be material in a “stack”: borrower leverage; fund-level credit facilities; securitisation vehicles; and investor-level leverage. Official analysis highlights that these multiple layers can magnify losses and transmit stress to leverage providers, particularly when reporting gaps obscure exposures.
Broader global policy work stresses that leverage in non-bank finance can be an amplifier of stress and that authorities need effective monitoring frameworks, better data, and proportionate tools that address both activities and entities.

Governance and decision rights. Governance is not cosmetic: it determines how exceptions are handled, how valuations are challenged, how conflicts are surfaced, and how workouts are run. Regulatory valuation reviews have repeatedly highlighted weaknesses where record-keeping is poor, independent challenge is thin, or portfolio managers effectively mark their own books.

Valuation methodology, frequency, and “dealing alignment”. Where subscriptions/redemptions are priced off NAV, mismatches between dealing frequency and valuation frequency can create unfairness between entering, exiting, and remaining investors, especially under stressed conditions.
Regulatory surveillance of private credit funds has also flagged absent or incomplete valuation policies and weak disclosure around impairments and watchlist/workout proportions—precisely the information investors need during stress.

Conflicts of interest. Conflicts are often structural: fees linked to valuations; allocation of deals across funds with overlapping strategies; the use of NAV-based borrowing; and economic incentives to smooth returns. Regulatory reviews emphasise identifying, documenting, and mitigating these conflicts, rather than assuming they are self-evident.

Fee structures and “extra” economics. Private credit can include multiple fee and income streams beyond a headline management fee—origination fees, extension fees, restructuring fees, default interest, and borrower-paid fees. Surveillance work has found inconsistent disclosures and cases where managers retained borrower fees or default-related income without clearly framing and quantifying it as a cost borne by investors.

An institutional due-diligence framework family offices can apply

Institutional diligence is best thought of as a repeatable operating system, not a one-off questionnaire. The aim is to reduce three failure modes: (i) buying a liquidity promise you cannot enforce; (ii) trusting valuations you cannot verify; and (iii) discovering only during stress that the credit process, leverage stack, or conflicts were poorly controlled.

Start with a written “investment intent” that is testable. Before meeting managers, write down—plainly—what job the allocation must do: income, capital preservation, duration/interest-rate exposure, inflation sensitivity, and whether returns must be cash-pay or can include payment-in-kind. Clarify non-negotiables: maximum drawdown tolerance; minimum liquidity horizon (years, not months); acceptable leverage; and concentration limits (per borrower/sector/sponsor). This is essential because private credit can look low-volatility on paper while embedding latent downside that only appears with lagged valuation marks.

Pre-investment diligence: strategy fit, track record, and underwriting edge.

A pragmatic strategy map helps avoid category error. Ask the manager to classify exposures across: senior secured direct lending; unitranche; junior/mezzanine; asset-backed or specialty finance; opportunistic or distressed; and any securitised or structured exposures. Your diligence intensity should rise as you move away from senior, well-collateralised, covenant-protected lending and toward areas where collateral verification, fraud risk, or valuation discretion is higher.

For track record, insist on evidence that separates cycle luck from process skill. In prose, structure questions like this:

  • “Show us the last full credit cycle you operated through, and identify what changed in underwriting after losses.”·     

  • “Provide a realised-loss history and recovery outcomes by strategy sleeve, not just fund-level IRR or ‘since inception’ returns.”·     

  • “Describe time-to-restructure and time-to-recovery in problem credits; what percent were amended vs defaulted?”

This matters because official analysis notes the sector has not experienced a severe downturn at its current size and scope; delayed loss recognition and subsequent markdowns are plausible in stress.

Underwriting diligence should focus on decision quality under pressure to deploy. Official research has flagged the risk that large pools of undeployed capital and the need to deliver returns within fund timeframes can weaken underwriting and covenant discipline.
Ask for specificity: 

  • Origination: “Where do deals come from, and what percentage is proprietary vs broadly shopped?”·     

  • Screening: “What are the top three reasons deals are declined? Provide examples from the last quarter.”·     

  • Committee discipline: “Who can veto? How often does the committee overturn deal-team recommendations?”·     

  • Covenant posture: “Do you use maintenance covenants? How have covenant packages changed since 2021–2022?”·     

  • Documentation: “Who controls the documentation process, and how do you ensure terms are enforceable across jurisdictions?”

Fund liquidity terms, gates/lock-ups, and product design.

A core institutional principle is: treat liquidity terms as risk factors, not features. If a fund offers periodic redemptions, diligence should mirror the standards being embedded into modern liquidity regulation and guidance for open-ended funds. International recommendations stress consistency between asset liquidity and redemption terms, and robust use of liquidity management tools supported by stress testing.

In addition, a major regional bloc’s 2024 fund directive requires open-ended funds to pre-select at least two liquidity management tools and include conditions for their use in fund rules—explicitly reflecting regulatory recognition that open-ended structures holding illiquid assets can create mismatches.

Translate those principles into a practical review of the fund’s mechanics:    

  • Dealing vs valuation: If subscriptions/redemptions are more frequent than robust valuation updates, you face a fairness problem between entering and exiting investors.    

  • Gate design: Is the gate a hard mechanical cap (automatic) or discretionary? What happens under queues—pro rata, first-in-first-out, or manager discretion?

  • Redemption tools: Are there notice periods, extensions, in-kind redemptions, side pockets, redemption fees, or anti-dilution tools—and are they actually operationally executable?     

  • Source of distributions: Surveillance has cautioned that regular distributions should be sustainable and predominantly sourced from underlying cash flows rather than investor capital, especially in strategies where loans do not generate cash in early phases (e.g., development financing).

Legal terms, side letters, and governance rights.

Institutional allocators treat the limited partnership agreement (or equivalent) as a risk-control document. In text-based diligence, prioritise:    

  • Key-person and suspension mechanics: What happens if the named principals depart? Is investment activity paused automatically?    

  • Investment restrictions and drift controls: Are there enforceable limits on strategy sleeve drift, leverage, borrower concentration, and related-party transactions?     

  • Advisory committee powers: Does a committee approve conflicts, valuation disputes, or material policy changes?    

  • Transparency rights: Are you entitled to asset-level data, watchlists, covenant breaches, and impairment rationale?     

  • Side letters and preferential terms: Can any investor receive better transparency, liquidity, or fee economics? If yes, what “most favoured nation” protections exist?

A useful heuristic is to assume the difficult scenario: you are unhappy during stress. Then ask, “What contractual levers do we actually have, and how quickly can we use them?”

Stress-scenario modelling that combines credit losses and liquidity.

Institutional stress testing is not a spreadsheet ornament; it is a decision tool. International guidance for collective investment schemes emphasises running both normal and stressed scenarios, using historical and hypothetical forward-looking scenarios, and documenting the process; it also highlights reverse stress testing (starting from the point where liquidity tools would be triggered and working backwards).

A family-office-appropriate approach—still institutional in spirit—can be structured in prose as follows:

1) Define the shock narratives (three is enough).
- “Mild” stress: slower growth, modest default uptick, refinancing spreads widen.
- “Severe” stress: recession plus refinancing shut; covenant breaches rise; restructurings extend.
- “Liquidity” stress: elevated redemption requests (if applicable) plus reduced ability to sell or finance assets.

2) Translate narrative into parameters.
Use ranges, not point estimates: default rate; recovery rate; time-to-recovery; % of portfolio moved to non-accrual; % of loans amended; haircut on marks for comparable public credit widening; and borrower interest coverage deterioration.

3) Layer in leverage and funding mechanics.
Incorporate borrower leverage, fund-level borrowing (including facilities secured by NAV), and any maturity mismatch created by investor liquidity promises. Official analysis and surveillance repeatedly flag that leverage layers and fund-level facilities can transmit stress.

4) Test investor outcomes, not just NAV.
Model distributions (cash income vs pay-in-kind increases), gate activation likelihood, and “time to liquidity” under queues.

5) Pre-define escalation triggers.
For example: “If non-accrual exceeds X%” or “If redemptions exceed available liquidity buffers and the fund proposes gating”, require an ad hoc investor call, enhanced asset-level reporting, and independent valuation review.

Operational due diligence: controls, valuation policy, NAV process, audit, custody, IT/security, compliance.

Operational due diligence is where most allocation mistakes become visible—because it tests whether the manager can produce reliable information when markets are calm and when they are not.

Valuation governance is a priority area in multiple regulatory reviews. Key expectations that can be converted into diligence questions include: clear accountability; detailed record-keeping of how valuation decisions are made; functional independence of the valuation process from portfolio management; expertise of committee members; and processes for ad hoc valuations when conditions change.
Translate that into an evidence-based request list:     

  • “Provide your valuation policy, including triggers for interim revaluations.”     

  • “Provide sample valuation committee minutes (redacted) showing debate and challenge.”·     

  • “Explain how you avoid incentives to keep marks stable or delay markdowns, especially if fees depend on valuation.”     

  • “Describe how unit prices are struck and how valuation frequency aligns with dealing/entry-exit pricing.”

On service providers and controls, remain outcome-focused: segregation of duties; reconciliation; independence of administrator processes; audit scope; cybersecurity and access controls; incident response; and compliance monitoring. While the details vary by jurisdiction, the principle is stable: you want a control environment that can withstand stress without “manual overrides” becoming the norm.

Counterparty and credit risk analysis: borrower selection, collateral, covenant quality, monitoring.

Recent idiosyncratic events involving alleged collateral or receivables misrepresentation illustrate why credit diligence must extend beyond “macro views” into verification practices and monitoring discipline. Institutional allocators should insist on clarity in four areas:    

  • Borrower selection and concentration: sector exposure; sponsor exposure; top borrowers; and how correlated risk is managed.     

  • Collateral and perfection: lien structure; collateral valuation; borrowing base mechanics for asset-backed lending; and third-party verification.     

  • Covenant quality: covenant packages are not automatically “safer” in private credit; what matters is whether covenants are meaningful, monitored, and enforceable, and whether amendments become a way to delay loss recognition.     

  • Monitoring and escalation: define watchlists, triggers, and workout resources. Regulatory surveillance has emphasised the need for standardised monitoring frameworks, stress testing, consistent impairment approaches, and independent oversight.

A practical template in prose is to require a “five-credit walk-through”: “Pick two performing credits, two watchlist credits, and one impaired credit. For each: show underwriting memo, covenant package, last quarterly performance package, and current mark rationale.”

Pricing, fees, and alignment of interest.

Treat fees as both an economic issue and a conflict-of-interest issue. Regulatory surveillance has highlighted weak and inconsistent disclosure of borrower fees and instances where managers retained origination or default-related income without transparent quantification or classification as fees.
Institutional fee diligence therefore separates:     

  • Explicit fees: management, incentive/performance, admin and operating expenses.     

  • Embedded economics: borrower-paid origination/extension/restructuring fees; default interest; and any NAV-based borrowing costs.    

  • Who benefits and when: are borrower fees passed to investors, netted against management fees, or retained by the manager?

For alignment, focus on what is observable and enforceable: manager co-investment; clawbacks; hurdle mechanics; and governance rights to approve conflicts. Where NAV-based borrowing exists, note regulators’ concern that valuation-linked incentives can interact with NAV financing covenants.

Ongoing monitoring checklist and reporting expectations

Ongoing monitoring should be designed as a standing agenda: the goal is to detect drift and stress early, before liquidity tools are triggered or valuation disputes become acute. Global monitoring and stability work repeatedly emphasises data gaps and interconnectedness challenges, which makes investor-driven reporting discipline more important, not less.

Reporting cadence (minimum viable institutional package).
Expect a short monthly dashboard (if available), a quarterly deep dive, and ad hoc updates for material events (defaults, significant markdowns, gating, policy changes). Supervisory and regulatory expectations increasingly emphasise timely communication and documented processes around liquidity and valuation in stressed conditions.

Core metrics to request and track.     

  • Portfolio composition: number of borrowers; top exposures; sector mix; sponsor mix; geography; seniority and collateral mix.·     

  • Credit quality: default rate; non-accrual %; watchlist %; covenant breaches; amendments; payment-in-kind prevalence; realised losses and recoveries.·     

  • Valuation and impairments: frequency; ad hoc revaluations; rationale for major markdowns; percent of book marked by third party vs internal; evidence of challenge.·     

  • Liquidity and terms: current redemption requests (if applicable); queued redemptions; percentage gated; cash balance and near-cash; expected inflows/outflows; distributions and their sources.·     

  • Leverage: borrower-level leverage trends; fund-level borrowing utilisation; any quarter-end leverage movements; facility covenants and headroom.

Red flags that merit escalation.
Escalation should be pre-planned and proportionate. Common triggers include: a sustained rise in non-accruals; increasing reliance on payment-in-kind; repeated covenant amendments without commensurate pricing; mismatches between dealing frequency and valuation updates; significant quarter-end leverage changes; gating or changing redemption policies; and opaque impairment recognition. These are consistent with vulnerabilities highlighted in official stability analysis and regulatory surveillance.

A practical escalation ladder in prose:

1) Request an ad hoc investor call focused on facts: liquidity position, top exposures, and decision rationale.
2) Require enhanced asset-level reporting on impaired/watchlist credits and valuation changes.
3) Ask for independent valuation or third-party review on the largest disputed marks (where contractually possible).
4) Engage external counsel to interpret redemption rights, side-letter protections, and any proposed policy changes.
5) If governance rights exist, use advisory channels to challenge conflicts, allocation, or valuation governance; if liquidity rights exist, plan redemptions over time rather than reacting in a run-like manner.

Conclusion with actionable next steps

Private credit’s move into the mainstream is a macro-relevant development because it changes who supplies credit, how transparent that credit is, and how stress can propagate—particularly when periodic-liquidity structures, valuation discretion, and layered leverage intersect.

The “first stress tests” have not required a full-cycle crisis to be instructive. They have already demonstrated where institutional discipline matters most: understanding redemption mechanics in practice; demanding valuation governance that withstands scrutiny; identifying hidden leverage and interlinkages; and verifying that underwriting and monitoring are robust enough to handle idiosyncratic credit events.

Actionable next steps for a family office seeking institutional-grade process:     

  • Write a one-page “allocation intent” and constraints document before manager selection.     

  • Build (and reuse) a diligence memo template that forces evidence: track record splits, underwriting examples, valuation governance artefacts, and liquidity tool mechanics.     

  • Run a combined credit-and-liquidity stress narrative, including reverse stress logic where relevant.   

  • Establish a monitoring calendar and a pre-agreed escalation ladder so that decisions under stress are procedural, not emotional.

Sources:

Report Generated by The ALFA Group

Theo Webb
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