Large banks have offloaded riskier loans to private credit, which is now more accessible to retail investors. According to Crossmark's Victoria Fernandez, this concentration of risk in a less transparent market, where "cockroaches" may be hiding, is a primary systemic concern.

The biggest worry in private credit isn't established players, but "tourists" who lack workout expertise. In a downturn, they may fire-sell loans below economic value, creating a negative feedback loop for the entire market, which has not yet been stress-tested.

While private credit is a viable asset class, Ed Perks expresses caution. The tremendous amount of capital flooding the space creates pressure to deploy it, which can lead to less disciplined underwriting and potential credit quality issues. He notes this space warrants close monitoring due to its lack of transparency.

Unlike institutional drawdown funds that call capital as needed, many retail private credit funds take investors' cash upfront. This creates immense pressure to deploy capital quickly to avoid performance drag, leading to weaker underwriting standards (e.g., weaker covenants, lower rates) in a hyper-competitive environment.

During the 2021-22 peak, private credit firms abandoned profit-based underwriting for "Annual Recurring Revenue" (ARR) loans to software companies. They gambled these companies would become profitable. Many have not, creating a vintage of bad loans that now poses a significant risk to the lenders who changed traditional lending economics.

After PIMCO's highly profitable $2 billion gain on a loan to a Meta data center, other private credit lenders are piling into the space. This fierce competition is driving down rates and weakening investor protections like covenants, a classic sign of a frothy market nearing its peak.

The fundamental model of private credit is sound. The primary risk stems from the sector's own success, which has attracted massive capital inflows. This creates pressure for managers to deploy capital, potentially leading to weakened underwriting standards and undisciplined growth.

The underwriting quality in private credit is declining. Key red flags include lenders accepting "EBITDA add-backs"—projected, unrealized earnings improvements—and allowing borrowers to retain more proceeds from asset sales. These terms signal a shift in negotiating power to borrowers and rising risk.

The recent surge of retail capital into private credit had a tangible market impact, forcing managers to deploy capital quickly. This resulted in tighter spreads and weaker lending terms. As these flows moderate, this trend is reversing, creating better opportunities for new investments.