Separating Signal from Noise in Private Credit

By The Nicola Private Debt Team

Over the past six months, a steady drumbeat of unflattering headlines has targeted the asset class, stoking fear among investors. Critics warn of hidden problems beneath the surface, vulnerability to AI-driven disruption, and a looming rise in loan defaults.

If you relied solely on the headlines, you might conclude that private credit is entering a period of serious stress.

Perhaps this scrutiny was inevitable. Private credit spent the last five years enjoying what many dubbed a “golden age.” Higher interest rates and attractive loan pricing allowed private credit funds to target double-digit returns, while lending against assets that sit at the very front of the repayment line if something goes wrong. Managers steadily took market share away from traditional Wall Street banks by financing larger companies, reshaping the corporate lending landscape. It’s not entirely surprising that private credit now has a bullseye on its back.

Despite the headlines, actual outcomes tell a more balanced story. Returns have largely tracked expectations. Default rates remain in line with historical averages. For investors, the takeaway is not to ignore risk, nor to panic at every alarming headline. It is to focus on the fundamentals: conservative underwriting, transparency, diversification, and alignment of interests.

Let’s look at the facts.

Rising Default Warnings

In August 2025, headlines warned of an impending spike in private credit defaults. 

In reality, the default rate has not spiked. At the end of 2024, it stood at 1.8% and declined to 1.5% at the end of 2025, well below the elevated levels some had feared.

Low default rates were supported by continued resilience in the U.S. middle-market. Despite inflation, higher interest rates, tariffs, geopolitical risk, a bifurcated consumer landscape, and an economy in which stronger companies continued to grow while weaker ones fell further behind, most middle-market businesses modestly grew profitability through 2025. U.S. middle-market private companies grew revenue and EBITDA at annualized rates of approximately 2-3% through the year. That pace was slower than the prior year, but still steady. Many loans underwritten in the post-COVID era were also structured with greater discipline and more conservative documentation designed to withstand volatility.

That said, the story is not entirely one-sided. Since late 2023, competition among lenders has intensified. Some lenders, especially those under pressure to deploy capital, agreed to lend more money, charge lower interest rates, and accept fewer credit protections in order to win deals. These are choices that can backfire if conditions deteriorate. It’s also worth noting that default statistics capture only the most visible failures (i.e., payment defaults). The default rate doesn’t reflect borrowers that are struggling but still making their payments.

Looking ahead, KBRA forecasts default rates may rise to roughly 2.0% in 2026. Over the past five years, default rates have been largely unremarkable, ranging as high as 3.6% in late 2020 during the COVID pandemic and averaging 1.9% over that period. A moderate increase from today’s low levels would be neither surprising nor alarming, as long as lenders continue to follow conservative lending standards. Defaults may rise modestly, but current data does not support the notion of a systemic breakdown.

The Cockroaches Are Coming

In September 2025, two companies collapsed in quick succession. First Brands Group, an auto parts manufacturer that had aggressively expanded through debt-fueled acquisitions, filed for Chapter 11 bankruptcy. Weeks earlier, Tricolor Holdings, a subprime auto lender, filed for Chapter 7 liquidation amid allegations of fraud, including the double-pledging of the same assets as collateral across multiple lenders. In both cases, lenders were caught off guard by hidden debt and complex financing arrangements that did not appear clearly on the companies’ books.

J.P. Morgan CEO Jamie Dimon’s now-famous “cockroach” comment, “when you see one cockroach, there are probably more,” added fuel to the fire, and what followed was a rapid escalation from two company-specific failures to broader concerns about systemic risk.

The reality is that neither situation originated in what’s commonly referred to as private credit. Most of First Brands’ borrowing came from bank-led broadly syndicated loans held by institutional investors, not private credit funds. Tricolor’s financing was concentrated in off-balance sheet asset-backed securitizations which are typically arranged and sold by banks. Most high-quality private credit managers identified warning signs early and largely avoided both situations.

These events reinforce the importance of transparency, access to information, and disciplined underwriting. Notably, even J.P. Morgan—whose CEO voiced the cockroach concern—has committed $50 billion to building its own direct lending platform, signaling long-term confidence in private credit. But there are lessons to be learned: if a true downturn materializes, lenders who relaxed underwriting standards will feel it first.

AI Disruption and the Blue Owl Fallout

The most recent wave of fear stems from AI’s perceived threat to the software industry. Some fear AI isn’t just a tailwind to existing platforms, but an emerging direct competitor to software altogether.

In late January 2026, new AI capabilities showcased the technology’s ability to manage workflows that enterprise software has traditionally handled. Without the ability to differentiate future winners from losers, investors sold indiscriminately. Software equities sold off broadly; even Microsoft lost tens of billions in market value. Liquid tradeable loans to PE-backed software firms followed suit, driven not by deteriorating credit fundamentals, but by technical selling pressure and risk aversion.

Private credit inevitably got swept into this narrative. Software and technology companies account for roughly 25% of the private credit market, and some managers have built portfolios with heavy concentration in the sector. Software has historically been a reliable sector for public and private credit lenders, thanks to predictable cash flows, recurring revenue models, and sticky customer bases.

However, unlike the public markets, valuations in private credit don't move with investor sentiment.  Valuations in private credit are anchored to fundamental borrower performance and long‑term repayment prospects, rather than investor fears and short‑term market sell-offs that create price volatility. Ultimately, a lender’s risk of recovering loan principal depends on the borrower’s ability to generate cashflow, and make contractual payments until the company is sold or the loan refinanced.

While private credit borrowers aren’t immune to AI disruption, painting the entire sector with broad brushstrokes oversimplifies the issue. The landscape will evolve unevenly: some companies will adapt and integrate AI to defend their business or even use AI to grow faster, while others may get left behind. AI disruption risk, while potentially valid (and perhaps overstated), should not be confused with credit impairment.

Perhaps the AI fallout hit Blue Owl Capital the hardest. Blue Owl is one of the largest private credit managers, with a broad reputation for its expertise in software private credit.  While Blue Owl’s public diversified BDC (OBDC) reports software exposure of approximately 11%, CNBC recently quoted Blue Owl as having software exposure as high as 70% across its 200+ borrowers.  

Blue Owl was already the subject of negative headlines in late 2025, having failed to merge a wealth oriented private fund (OBDC II) with its publicly traded BDC (OBDC). Merging a private fund with a public BDC has been a successful playbook for over a decade, and it typically provides investors in the private fund with liquidity upon the merger. In Blue Owl’s case, OBDC II investors voted against the merger because it would have detracted from their returns. As a result, the $1.8 billion fund sought a normal course alternative path to liquidity for investors which included a $600 million secondary sale of loans at 99.7% of par value to several sophisticated pensions reinforcing the creditworthiness of the portfolio.

Despite the negative media attention investors should not confuse temporary illiquidity in private credit with credit impairment. OBDC II’s underlying loan portfolio has returned 9.1% annualized since 2017 through September 2025,  it is expected to continue to return capital to investors over time, and there is little evidence to date suggesting any systemic credit issues.

Discipline and Diversification

Not every loan default signals a systemic crisis. Not every fund that restricts redemptions is on the verge of collapse. And not every sector facing disruption is destined for obsolescence.

Context matters and so does portfolio construction.  

Our approach has always been to invest with discipline and diversification, and this philosophy applies to our own Nicola Private Debt Fund. The Nicola Private Debt Fund lends to over 130 individual middle-market companies, with no single borrower exceeding 2% of Fund assets.  This keeps concentration risk low by design to mitigate the return impact of individual borrower defaults. Exposure is spread across many different end-markets, including industrials, information technology, healthcare, financials, and business services sectors, rather than concentrated in any single sector. For example, our exposure to software as of Q4 2025 was around 11.7%. Within software, we focus on lending to mission-critical enterprise software companies that are deeply embedded in their customer workflows.

The Nicola Private Debt Fund lends primarily to U.S. middle-market businesses with proven cash flows, and our weighted average borrower EBITDA is over US$100 million. As of December 31, 2025, approximately 98.5% of the portfolio is senior secured, with meaningful covenants and documentation oversight throughout the life of each loan.

As of December 31, 2025, since inception in October 2017, the Fund has delivered a 7.6% annualized net return in Canadian dollars, with a worst 12-month period of +5.1% and has never experienced a capital decline. These are not extraordinary numbers. They reflect a straightforward philosophy: lend conservatively, diversify broadly, and don’t reach for yield at the expense of credit quality. 

In Conclusion

Private credit is not risk-free. Defaults will rise and fall with economic cycles. Certain sectors will face disruption. Some managers will underperform. That has always been true. What the recent headlines miss is that private credit is not a monolith. It is a fragmented, diverse market shaped by underwriting standards, portfolio construction, sector exposure, and—above all—manager discipline.

For investors, this isn’t a call to ignore risk, nor to react to every alarming headline. It’s a reminder to focus on what ultimately matters: conservative underwriting, transparency, diversification, and aligned interests.

 In an environment dominated by fast-moving narratives, the distinction between fact and fiction is rarely found in headlines. It’s found in fundamentals.  Over more than two decades, private credit has produced attractive returns and has often compared favourably with public fixed income.

We continue to monitor industry developments closely and welcome the opportunity to discuss how the current environment may relate to your portfolio.