Private credit markets have thrived in a low-rate, high-liquidity environment for years, with few defaults and steady returns. Restructuring experts and opportunistic investors warn that era is now ending.

High interest rates, struggling borrowers and risky deals from 2020 and 2021 are pushing lenders away from traditional lending and toward restructuring, rescuing or taking control over troubled companies, panelists said at the Debtwire Private Credit Forum in New York.

“After a period of not a ton of activity for restructuring folks like me, it’s gotten a lot busier,” said panelist Fran Blair, who leads restructuring and rescue finance at PSP Investments.

This is new territory for many of today’s lenders, according to the panelists. Senior secured debt has faced economic downturns before, but today’s private credit lenders haven’t, said Richard Miller, chief investment officer at TCW Private Credit.

“The asset class has certainly been tested, it’s bank debt, it’s over 100 years old,” he added. “Who provides it is different today, and this cohort of providers has not been tested.”

Stress under the surface

Panelists said at the 26 June event that despite tight spreads and stability on the surface, distress is building underneath.

“If you’re just looking superficially, US high-yield spreads over 350bps, which is on the historically tight side, there’s really not that much to see,” said Noah Charney, head of capital markets at King Street. “But underneath, about a quarter of the [BSL issuers] are cash-flow negative. I’m guessing the number is even higher in the private credit space and that’s a massive problem.”

Most of these are credits underwritten during the pandemic.

“Deals we financed in the 2021 context are starting to run into trouble, so we’re spending more and more time addressing that portion of our portfolio,” said Blair, who noted his team is completing more amend-and-extend and liability management exercise-type transactions to buy companies more time.

More issuers are now using PIK interest, which lets them skip cash payments and add the interest to their loan instead, which is a sign they’re short on cash.

“The amount of PIK being used in the marketplace has gone up dramatically,” said Miller. “That’s being ignored. And if you look at some of the statistics, something like 40% of companies out there don’t cover fixed-charge. That’s alarming.”

Even high-quality businesses are being brought into restructuring conversations, according to KKR’s Lauren Krueger. The companies themselves can be very good companies, but the cost of capital is higher and the structures put in place a few years ago weren’t built for this high-rate environment, she said.

Opportunistic investors step in 

As stressed companies hit liquidity walls, special situations investors are stepping in.

“Special situations investing is [the] classic ‘good company, bad balance sheet,’” said King Street’s Charney. “There’s dislocation or complexity that provides opportunity.”

Executives at Blue Owl, Oak Hill Advisors and BC Partners said they are seeing heightened demand for bespoke capital, including hybrid instruments, bridge financings, structured equity and non-control dividend deals.

“You can help solve for growth,” said Jesse Huff, co-head of opportunistic lending at Blue Owl. “It’s not necessarily troubled situations. There could be other situations where it’s a very well performing company.”

Panelist Patrick Schafer of BC Partners said what makes his firm stand out is the operational support it offers post-deal, not just the capital.

“We have an entire operating advisory group within our private equity firm that we can utilize on the credit side and it can be as simple as supply chain logistics or saving our portfolio company money through insurance savings,” he said.

The best opportunities, panelists said, are coming up in non-sponsor situations, post-buyout deals from 2020 and 2021, and assets facing “valuation opacity” from macroeconomic uncertainty.

“The beauty is in the eye of the beholder,” added Chris Kenny, managing director at OHA. “To be the folks who are willing to entertain and look at a business which may have some hair […] you actually find something beautiful that others may not find beautiful.”

Peter Ma, Co-Founder and Managing Partner of Square Nine Capital, emphasized speed and flexibility, noting that most of his team’s past activity has been outside of a traditional LBO framework where sponsor relationships aren’t entrenched.

“This is a great time to be investing in opportunistic credit. The M&A market has been slow. Obviously the tariffs have created a decent amount of uncertainty that makes it difficult to transact. And I think that type of backdrop does lead to a good environment for a capital solutions product.”

Charney also pointed to Europe as a growing opportunity. “We have been very active there,” he said. “I feel like what happens first in the US migrates to Europe later, and we’re starting to see more structured priming financings there, so we’re excited about the European opportunities over the next couple of years.”

Speakers added that valuation gaps, supply chain volatility and refinancing pressure in consumer and industrial names are all helping boost deal flow.

“There really is never a shortage of underperforming middle market borrowers,” Miller said. “There are always opportunities for this kind of opportunistic investing, where you’re providing liquidity to those in need. And history will tell you, if you can do that, you can drive pretty attractive returns.”

Tight documentation

Lenders are increasingly focused on legal protections. While recent liability management exercises in broadly syndicated loans raised concerns about LMEs in private credit, panelists said those worries have largely subsided.

“You don’t see the really nasty LMEs anymore,” said Blair. “We’re seeing a bit more friendly LMEs, pro-rata oriented, you still have ad-hoc groups who are negotiating the deal.”

But credit managers are still focused on preventing weakness in documentation.

“We construct lockdown docs,” Charney said. “People tend to focus on financial maintenance covenants and that matters, but it doesn’t matter as much as ‘do you have recourse to the collateral that you have lent against come hell or high water?’”

John Britton, a partner at Milbank, noted that protections around drop-downs, unrestricted subsidiaries and “lender-on-lender violence” are now standard in new large-cap private credit deals.

“That’s where you will see private credit looking at the provisions to stop LMEs, and there’s some more notorious cases like Envision or Pluralsight, moving critical assets of a business around,” he said. “You’ll see protection along those lines.”

Out-of-court and in-court restructurings 

When a capital injection can’t save a company, direct lenders have to be prepared to take the keys from the financial sponsor. Most funds aim to complete change of control deals out of court, though in some circumstances investors elect to use a Chapter 11 bankruptcy process.

“The cost of bankruptcy has gotten so crazy,” said Blair. “If you only have a handful of lenders that you need to get on board for an out-of-court restructuring, an Article 9, strict foreclosure, it’s so much less expensive to go about it that way.”

Fund managers like KKR are prepared to take control of companies by drawing on their wider teams.

“I think having the infrastructure to run and operate a company is very important,” said Krueger, adding that KKR has distressed private equity experts, Capstone turnaround advisors and outside operating professionals to help run the company post-restructuring.

Other funds simply elect to exit rather than wait to see if they can turn around a struggling investment.

“We’ve seen situations where a lender will just raise their hand and say, ‘I don’t like this restructuring deal, is there a cash‑out option?’ said Blair. “The sponsor will put a low number on the table and the lender will often take it.”