The 5% default rate in private credit, compared to 3% in syndicated loans, is a function of its target market: smaller companies. Just as the Russell 2000 is more volatile than the Dow Jones, smaller businesses are inherently riskier. Applying leverage to a more volatile asset pool naturally results in more defaults.

Howard Marks warns that during a downturn, private credit managers may avoid recognizing defaults by simply extending loan terms for struggling companies. This 'extend and pretend' strategy can mask underlying problems, keeping assets marked artificially high and delaying a painful reckoning for investors.

Default rates are not uniform. High-yield bonds are low due to a 2020 "cleansing." Leveraged loans show elevated defaults due to higher rates. Private credit defaults are masked but may be as high as 6%, indicated by "bad PIK" amendments, suggesting hidden stress.

Private lenders may offer a partial Payment-In-Kind (PIK) toggle as a strategic feature to win a competitive deal for a healthy company. This "PIK on purpose" is distinct from "bad PIK," which occurs when a struggling company cannot service its cash interest payments and is forced to capitalize them.

The increase in Payment-In-Kind (PIK) debt to 15-25% of BDC portfolios is not a sign of innovative structuring. Instead, it often results from "amend and extend" processes where weakened companies can no longer afford cash interest payments. This "zombification" signals underlying credit deterioration.

Private equity giants like Blackstone, Apollo, and KKR are marking the same distressed private loan at widely different values (82, 70, and 91 cents on the dollar). This lack of a unified mark-to-market standard obscures true risk levels, echoing the opaque conditions that preceded the 2008 subprime crisis.

Problem loans from the 2021-22 era will take years to resolve due to private credit's tendency to "kick the can." This will lead to a prolonged period of underwhelming mid-single-digit returns, even in a strong economy, rather than a dramatic bust.

A consistent 2-5% of Europe's public high-yield market restructures annually. The conspicuous absence of a parallel event in private markets, which often finance similar companies, suggests that opacity and mark-to-model valuations may be concealing significant, unacknowledged credit risk in private portfolios.

Official non-accrual rates understate private credit distress. A truer default rate emerges when including covenant defaults and 'bad' Payment-in-Kind interest (PIK) from forced renegotiations. These hidden metrics suggest distress levels are comparable to, if not higher than, public markets.