How private credit's cracks are threatening to deepen private equity's woes
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Private credit's rapid rise has been key to global dealmaking for more than a decade. Now, signs of strain in the $3 trillion market are raising a bigger question: how far the fallout from private credit could spread into private equity. The two pillars of private markets have become deeply intertwined over the past decade, with direct lenders stepping in as a key financing engine for buyouts after banks retreated following the global financial crisis, according to industry veterans. "The majority of the PE ecosystem has been financed from private credit," said Kyle Walters, a private capital analyst at PitchBook. "The two sides are structurally entangled when it comes to deal activity." For private equity firms, direct lenders offer faster execution and more flexible, bespoke financing structures, making them a preferred partner for leveraged buyouts. About 80% of all private equity leveraged buyouts are funded by private credit, said Johns Hopkins Carey Business School's senior finance lecturer Professor Jeffrey Hooke. Private credit strains will impact new private equity deals and existing portfolio companies, as lenders grow more cautious and borrowing costs rise. A renewed focus on stricter underwriting, including wider spreads and stronger protections for covenants — contractual promises — is making financing more expensive and restrictive for buyouts, according to PitchBook's Walters. For companies already owned by private equity, the impact is quite acute: higher interest burdens, tougher refinancing conditions and increased covenant pressure are squeezing cash flows, particularly for highly leveraged borrowers, experts said. That leaves firms which relied on cheap, abundant credit during the low-rate era of 2010s and early 2020s more exposed, with weaker companies struggling to roll over debt or exit investments. At the same time, declining loan valuations — markdowns in the value of loans extended by private credit funds — are signaling stress at the company level, forcing private equity managers to mark down asset values and accept lower returns, said Hooke. "That will [also] slow any new private equity funds," said Hooke. "The more leveraged private equity deals are most at-risk. Most investors have no choice but to ride it out." Consultancy Greysparks highlighted that more than 81% of private credit assets under management sit at firms that also run private equity funds, underscoring how concentrated the market is among large private capital managers. That intimacy is now amplifying risks. Private equity already under pressure Experts highlight the risk of a negative feedback loop: weaker credit conditions hurt portfolio companies, which in turn depresses their valuations and exits, further constraining fundraising and deal activity. "PE-backed companies were already in a fragile place," PitchBook's Walters said, pointing to aging assets and exhausted value-creation strategies such as cost-cutting, financial engineering and multiple expansion. Credit stress now adds "a distinct additional force." Tighter lending conditions are directly hitting deal economics. As lenders become more cautious, buyout firms are forced to use less debt to finance acquisitions, pulling down offer prices and compressing valuations across the market, he explained. Refinancing risks are also rising. Companies that relied on flexible, bespoke private credit loans during the low-rate era are now finding it harder and more expensive to roll over debt, particularly those in sectors facing structural disruption. Private equity portfolio companies were already under pressure before the recent bout of credit stress. Many were acquired between 2019 and 2022 at elevated valuations and financed with aggressive leverage, assumptions that are now being tested in a higher-rate environment. Lucinda Guthrie, head of Mergermarket, said global private equity buyout activity declined 14% year on year in the first quarter, as geopolitical uncertainty, private credit market jitters and scrutiny on AI from investment committees create a more challenging environment for investors. "The disruption in private credit no doubt will reduce private equity new investments," said New York University's Stern School's professor of finance, Edward Altman. Private equity and private credit have lost their halo of always outperforming. Verdad Advisers Dan Rasmussen Additionally, a deeper concern for investors is that the current episode is exposing structural weaknesses in the private market model itself. "The fundamental sales pitch of private credit is high yields at low risk," said Dan Rasmussen, founder of Verdad Advisers. "For the first time, allocators are confronting the idea that private might not be better." "Private equity and private credit have lost their halo of always outperforming," Rasmussen added. Large alternative asset managers, with both private credit and private equity businesses, are so far striking a measured tone, acknowledging pockets of stress while emphasizing resilience. Ares CEO Michael Arougheti reportedly said that there were "no signs of a major default cycle," arguing that stress is largely cyclical rather than systemic, even as some funds across the industry have imposed redemption limits to manage rising investor withdrawals. Recent comments from JPMorgan's Jamie Dimon suggested a cautious view on risks to private credit. Dimon said the rapidly growing asset class is not a systemic threat to the broader financial system, despite mounting scrutiny over rising defaults, fund outflows and sector-specific pressures such as AI disruption. Speaking on a recent analyst call, Dimon also pointed to some easing in underwriting standards across the market, noting that the trend extends beyond private credit. "There's been some weakening in underwriting, and that's not just by private credit," he noted. The bank had around $50 billion in exposure to private credit in the first quarter, part of its broader lending to non-bank financial institutions, according to Reuters.