Private Debt News Weekly Issue #74: Shadow Defaults, Equity Conversions, and the PIK Time Bomb
Lincoln International flags 6% "shadow default rate" from bad PIK while lenders swap debt for equity across Europe as Ares sees opportunity in market chaos
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Private credit has a shadow default problem. Lincoln International is tracking what it calls “bad PIK” added during loan life to ease cash flow pressure, and that metric hit 6% in recent data, up from 2% in 2021. The valuation firm views this as a “shadow default rate” in an industry that masks stress through loan amendments.
According to Lincoln, the percentage of loans with some form of PIK rose to 11.4% in Q2 from 6% in 2022, with more than half containing the problematic version. JPMorgan analysis of 29 BDCs showed PIK loans increased to $43.5 billion in Q2, representing approximately 15% of total debt portfolios.
“PIK is a way of avoiding defaults, so we’re not thrilled by it,” said Vijay Padmanabhan of Cambridge Associates. “We understand why it’s done, but it’s something we would classify as a concern.”
The stress is manifesting in accelerating debt-for-equity swaps as lenders become reluctant equity owners. Recent conversions include British auction house Bonhams, telecoms supplier Netceed, Italian sportswear maker Dainese, and French radiology specialist Oradianse. According to Tamsin Coleman of Mercer, “if that’s showing up in strategies where it shouldn’t be, like a senior direct lending strategy, that’s concerning.”
Yet official default rates tell a different story. Fitch reported US private credit defaults decreased to 5.4% on a trailing 12-month basis through September from 5.5% through June. There were 14 new defaults in Q3 across 1,200 borrowers tracked, bringing the total to 65 for the period.
Ares Capital CEO Kort Schnabel sees opportunity in the chaos, arguing First Brands and Tricolor actually make private credit “look good” while presenting chances to grab market share. According to Schnabel, “that’s a great time for private credit” when broadly syndicated markets see reverberations.
Wall Street executives largely dismissed systemic risk concerns despite setting aside hundreds of millions in provisions. Goldman CEO David Solomon said he doesn’t “see anything in the context of a handful of bad credit situations that’s leading me to say we have a systemic issue around the corner.” BNP Paribas booked €905 million in Q3 provisions including €190 million for one specific credit while HSBC set aside $1 billion including $100 million for a single Middle East client.
But the PIK problem keeps growing. More than 40% of direct lending borrowers had negative free operating cash flows at year-end 2024 according to IMF data, prolonging PIK reliance. PineBridge’s Hani Redha warned that “deferred interest could quickly turn into deferred pain” with defaults expected to rise in 2021-2022 vintages during 2026 and beyond.
Key Market Themes
1. Debt-for-Equity Wave Signals Credit Stress
Arcmont Asset Management and HPS Investment Partners took control of Italian sportswear maker Dainese after providing €25 million in fresh funding over summer to stabilize the business. According to company statements, the transaction is expected to close in early 2026 after Carlyle Group walked away from the struggling brand.
Dainese’s losses nearly tripled to €120 million last year after Carlyle’s 2022 buyout, forcing debt negotiations with creditors. Arcmont and HPS had funded the acquisition with €285 million in private bonds, according to market sources.
Separately, Pemberton Asset Management, Blue Owl, and Hayfin Capital Management executed one of Europe’s largest debt-for-equity swaps to take control of telecoms supplier Netceed. According to people familiar, all creditors agreed to write off debt in exchange for ownership stakes while Netceed gains access to €70 million of liquidity.
Quiet Capitulation
Netceed’s debt structure includes over $1 billion of term loans, much held by private credit lenders, according to sources. The company has been grappling with deteriorating finances partly due to lower demand from Altice USA and Altice France clients struggling with their own debt piles. These represent peaceful handovers rather than contentious bankruptcies: sponsors walking away quietly.
2. Sixth Street Warns of Lower Returns Ahead
Josh Easterly, Sixth Street co-CIO, told Bloomberg TV that private credit investors should prepare for lower returns with more rate cuts expected and credit spreads tightening. According to Easterly, investors will likely see “underwhelming returns compared to what they were expecting versus outright losses.”
Easterly argued that “private credit can disappoint, maybe there are managers that will disappoint given the proliferation of the asset class” while banks are “trying to protect their big profit pool on high-yield, leveraged loan underwriting.” According to his assessment, “both those narratives can be true.”
For Sixth Street, having scale and ability to shift across strategies is central to producing desirable returns. According to Easterly, “we think the key is having a big platform, and being able to move from asset class to asset class, where we don’t have to do direct lending if the risk-reward isn’t right.”
Unusual Candor
The admission that returns may disappoint represents rare honesty from a major industry player, especially as peers report record AUM growth. According to market observers, Easterly’s comments suggest managers are positioning defensively ahead of potential underperformance across the cycle.
3. Blackstone Credit Hits $508 Billion Despite Warnings
Blackstone reported credit AUM surged 18% year-over-year to $508 billion with particularly strong growth in higher-grade debt investing. According to the firm’s Q3 results, private investment grade strategy grew 33% year-over-year to $123 billion as the firm pushes beyond traditional sub-investment grade corporate credit.
Blackstone set a $1 trillion ten-year target when it consolidated credit and insurance two years ago. According to Gilles Dellaert who leads the unit, “if you were able to look at the composition of our business today versus two years ago, you’re going to see an increased allocation of the pie towards higher quality, investment grade or high grade credit.”
Insurance assets at Blackstone grew to $264 billion, a 19% year-over-year increase. Firm-wide distributable earnings surged 48% in Q3 fueled by investment exits from private equity.
Performance Warnings
According to Dellaert, the $1.7 trillion industry will start seeing “real dispersion in performance between funds through the credit cycle” with numbers that “used to be very close to one another” now becoming “quite different.” Vulnerabilities may lie among funds that “went to parts of the lower middle market” or riskier ecosystem segments. According to Dellaert, “at a time when underwriting standards and documents are looser, the recovery rates will probably be worse than some people expect.”
4. Saudi Arabia Emerges as Deployment Battleground
Goldman Sachs, Apollo, and other titans are positioning for deals in Saudi Arabia where bank liquidity has been drained by Crown Prince Mohammed bin Salman’s Vision 2030 diversification projects. According to David Beckett of SC Lowy, “in some cases, banks are even referring deals to us because they’re unable to finance them.”
Medium-term loans in Saudi Arabia dropped for the first time in three years last quarter as local banks focus on government mega-projects. According to Monica Malik of Abu Dhabi Commercial Bank, “the critical issue remains the tightness in domestic liquidity with credit demand outstripping deposit growth.”
Goldman is relocating a top private credit executive from London to the Middle East while Saudi Arabia’s Public Investment Fund agreed to anchor new funds from Goldman’s asset management unit focusing on private credit and public equity across the six GCC countries. Golub Capital, Blue Owl, and HSBC-backed Saudi Awwal Bank are also expanding aggressively.
Capital Desperation
According to Farouk Soussa, Goldman’s MENA economist, “the liquidity constraints and capital situation of the domestic banks create a real opportunity.” Marc Pinto of Moody’s noted “there’s a lot of talk about how great financing needs are in Saudi Arabia” with big players like KKR and Apollo “sniffing around” but needing deeper understanding of where funding needs are greatest.
5. Monthly NAV Updates Sacrifice Opacity for Scale
Private credit managers are moving to monthly NAV updates to attract retail investors, abandoning traditional quarterly reporting. According to Brian Garfield of Lincoln International, “we’ve seen a tremendous upshoot in the number of valuations that we’re doing more frequently than quarterly.”
Approximately 20% of Houlihan Lokey’s direct lending clients now require monthly valuations, up from rare exceptions five years ago, according to Rittik Chakrabarti, co-head of US portfolio valuation. Interval funds have raised almost $123 billion of capital as of Q3, up 9.4% from the prior quarter with almost two-thirds dedicated to debt and fixed income.
According to Therese Icuss of Fidelity at the CAIS Summit, “right now, 100% of our portfolio is marked by a third party every single month” based on performance with monthly financial updates from borrowers meaning “there’s no latency in our NAV.”
Limited True Transparency
Despite more frequent NAV calculations, many firms still aren’t providing monthly updates on individual loan values within portfolios. According to Barbara Niederkofler of Akin Gump, investors shouldn’t confuse more frequent marks with trading ability since “these products are not like mutual funds where you can go to an online broker and decide that you want to trade.”
6. Short Sellers Bank $127 Million Then Cover
Short sellers netted over $127 million in the last 30 days from wagers against the 10 biggest publicly traded BDCs, according to S3 Partners analysis. The bets were up 8.7% in the period with shorts making “all of their year-to-date profit” in that timeframe.
Total shorts against BDC stocks stand at approximately $1.22 billion according to S3, though short interest has trended down at many lenders in recent weeks per S&P Global Market Intelligence data. The S&P BDC Index fell to its lowest level in about three years earlier this month.
According to S3’s report, “expect more volatility in this sector if more credit and default issues become known” but “if interest rates continue to decline, credit risk decreases, we may see short covering as short sellers look to realize their recent mark-to-market profit windfall.”
Profit Taking Signal
The trend suggests sophisticated investors are taking profits after successful bets against BDC valuations rather than adding to positions. According to market participants, the short covering could provide temporary support for BDC prices if credit conditions stabilize, though the $127M one-month haul demonstrates how aggressively the sector repriced.
7. Industry Leaders Split on Systemic Risk
KKR co-founder Henry Kravis pushed back hard against systemic concerns, telling Bloomberg TV that “not one penny of private credit” was involved in Tricolor or First Brands bankruptcies. According to Kravis at the Berlin Global Dialog, since firms like KKR don’t take deposits, “there’s no systemic risk” from private credit as an asset class.
Kravis acknowledged concerns about inexperienced entrants, stating “I worry about those firms that don’t have a driver’s license, that have decided they want to get into private credit, have no way to drive, haven’t passed a test or anything” but insisted “I don’t find it systemic.”
Zions CEO Harris Simmons took the opposite view, warning of a “yellow flag” given the sector’s rapid growth. According to Simmons on an earnings call, the greater concern is “spillover risk if or when that private-credit sector finds itself in creative stress” since nonbank lenders lack the “structural backstop of liquidity” that banks have with the Federal Reserve.
Wells Fargo’s Middle Ground
Wells Fargo CEO Charlie Scharf offered a measured view, saying “worry is a strong word” while noting credit quality at Wells Fargo has been “exceptionally good.” According to Scharf at the Economic Club of New York, there’s a “very, very big difference between what could be a fraud and what is a credit issue driven by poor performance.”
8. Banks Return with $12 Billion Mega-Deal
Citigroup, Barclays, Bank of America, and RBC Capital Markets are providing $12.25 billion of debt financing to support Blackstone and TPG’s acquisition of medical device maker Hologic. According to regulatory filings, the package includes $9.5 billion of first-lien term loans, $2 billion of second-lien debt, and a $750 million revolver.
Citigroup will lead a first-lien dollar tranche, Barclays and Bank of America will lead euro-denominated first-lien debt, and RBC is expected to lead the second-lien portion, according to people familiar. SMBC has also committed to the financing.
The deal marks continued acceleration in large M&A after three years of depressed volumes. Blackstone and TPG agreed to acquire Hologic for as much as $18.3 billion, paying $76 per share upfront with up to $3 more per share if certain business targets are hit.
Competitive Dynamics
The bank-led financing demonstrates traditional lenders remain competitive for mega-deals despite private credit’s growth. According to market participants, banks are reclaiming share in large M&A financing while private credit focuses on middle-market opportunities and asset-backed structures.
Deals of Note
Hologic - Citigroup, Barclays, BofA, and RBC lead $12.25B financing for Blackstone-TPG acquisition: $9.5B first-lien, $2B second-lien, $750M revolver
ChemOne Malaysia - $600M private credit loan for chemical processing complex construction in Southeast Asia
Oaktree-Perpetual - Private credit financing for Oaktree’s acquisition of Australian wealth management unit, terms undisclosed
NatWest SRT - £2B of private market fund loans earmarked for significant risk transfer
The Bottom Line
When private credit lenders swap debt for equity and take companies from PE sponsors, that’s not restructuring. That’s admitting the equity is worthless. Arcmont and HPS taking Dainese after €120M losses, Pemberton and Blue Owl swapping over $1B of Netceed debt, these are quiet capitulations that don’t show up in default statistics.
Sixth Street’s Easterly warning investors face “underwhelming returns” while Blackstone reports 18% AUM growth to $508B creates obvious tension. Everyone’s deploying but the smart money is lowering expectations. According to Easterly, “private credit can disappoint” and managers without flexibility to pivot will struggle. Blackstone’s Dellaert echoing concerns about performance dispersion confirms what Easterly won’t say directly: not everyone survives. Numbers that “used to be very close” are becoming “quite different” with vulnerabilities in lower middle market credits where “recovery rates will probably be worse than some people expect.”
The Saudi Arabia scramble demonstrates capital desperation. Goldman relocating London executives to chase deals that local banks can’t fund because they’re maxed out on government mega-projects isn’t strategic expansion. That’s $1.7T seeking deployment wherever opportunities exist. Monthly NAV updates sacrifice opacity for retail scale with 20% of clients now requiring monthly valuations versus rare exceptions five years ago. But monthly marks on illiquid loans don’t create liquidity, just more frequent dispute opportunities.
Short sellers banking $127M in 30 days then covering tells the story: sophisticated money made its bet, won, and moved on. Kravis insisting “not one penny of private credit” touched Tricolor or First Brands while Zions CEO warns of “yellow flags” and “spillover risk” shows the industry can’t agree on its own risk profile. When a KKR co-founder and major bank CEO see completely different risk levels, someone is badly wrong.
The debt-for-equity swaps, return warnings, Saudi capital chase, and systemic risk debate all point one direction: the growth phase is over and differentiation has begun. Performance will diverge and some recoveries will disappoint. The only question is how many managers figured that out before their investors did.