Growth scrutiny and late-cycle stress can raise credit risks

The Impact of Regulatory Reforms and Lending Constraints

In the aftermath of the great financial crisis of 2008, banks faced significantly tighter capital and liquidity constraints driven by regulatory reforms and heightened risk oversight. These pressures curtailed traditional bank lending, particularly to leveraged middle-market borrowers, creating a financing gap that less-regulated alternative lenders were well positioned to fill. Private credit funds emerged as a flexible source of capital, offering bespoke structures, speed of execution, and higher yields, which attracted both borrowers and institutional investors. Over time, this dynamic fueled rapid growth in private credit, establishing it as a durable and increasingly central component of private capital financing.

This trend was further reinforced by an extended period of ultra-low interest rates, with policy rates sustained near zero throughout much of the 2010s and again during the COVID crisis in 2020, when the Federal Reserve injected roughly $3 trillion of new liquidity into the system in a single year. Yield compression across traditional fixed-income markets pushed institutional investors toward private credit in search of yield and downside protection. As inflation accelerated during the subsequent recovery, monetary policy reversed sharply, triggering the most aggressive interest rate tightening cycle since the early 1980s. As rates increased, the floating-rate structure of private credit lending enabled yields to rise materially with higher base rates, reinforcing investor demand and solidifying its role within modern private capital financing.

More recently, the prolonged “higher-for-longer” interest-rate environment has begun to place meaningful strain on over-levered middle-market private companies. Elevated base rates have driven up debt-service costs, compressing free cash flow and limiting financial flexibility, particularly for sponsor-owned businesses that were capitalized during the low-rate period. There has been a noticeable increase in the use of payment-in-kind (PIK) and other non-cash financing structures as borrowers seek to preserve liquidity. According to Fitch Ratings, loans carrying PIK provisions, where interest accrues to the balance of the loan as opposed to being paid in cash, made up roughly 8% of business development company (BDC) loan holdings by value in mid-2025¹. This represents approximately double the 4% level observed in the pre-COVID period, highlighting how non-traditional financing structures have increased as lenders adapt to more cash-constrained borrowers in a persistently higher-rate environment.

Bankruptcies, Defaults, and Investor Behavior

As a result of the higher-for-longer interest rates, U.S. bankruptcies in 2025 reached a level not seen since the aftermath of the financial crisis, a fifteen-year high. Higher defaults in private credit funds have led to reporting suggesting that the private credit market may be entering a more complex and scrutinized phase². Recent financial reporting suggests that individual investors have begun pulling money out of private credit funds at a noticeable pace due to a combination of high-profile bankruptcies, lower yields, and a growing concern around credit quality and underwriting scrutiny. Investors are also feeling growing unease around the semi-liquid nature of these funds, which only offer periodic redemption features while investing in fundamentally illiquid loans due to the lack of an active secondary market

Retirement Savings and Structural Evolution

At the same time, Bloomberg⁴ reported in January 2026 that private credit managers are accelerating efforts to launch new fund structures designed to tap retirement savings. Late last year, President Trump signed an executive order with the aim of “democratizing” retirement investing by easing restriction on the inclusion of alternative assets, such as private credit, into 401(k) plans. These vehicles, which are intended to be compatible with 401(k) plans and other long term investor channels, could add additional momentum to an asset class facing late-cycle pressures. This push may reflect confidence in private credit’s long-term prospects, or an acknowledgment that future growth increasingly depends on broadening the investor base beyond institutions and high net worth individuals.

Implications for Directors and Officers (D&O) Insurance

Collectively, these market trends suggest that private credit is entering a period of transition, expanding into more retail-oriented investor channels at the same time it is being tested by tighter liquidity conditions, rising credit stress, and late-cycle dynamics.

These conditions have direct implications for private company Directors and Officers (D&O) insurance. Periods of financial stress historically correlate with increased D&O litigation risk, particularly as companies pursue complex debt restructurings, liability management exercises (LMEs), or ultimately enter formal insolvency proceedings. As liquidity tightens and refinancing options narrow, board and management decisions around capital structure, valuation assumptions, and stakeholder communications are subject to heightened scrutiny. Claims frequently arise not simply from adverse outcomes, but from allegations that risks were inadequately disclosed, conflicts were insufficiently managed, or fiduciary duties were allegedly breached during periods of financial stress.

Credit Deterioration: Borrower Access and Future Outlook

Heightened scrutiny of private credit as an asset class also has downstream implications for private companies that rely on it as a primary source of financing. As credit conditions deteriorate later in the cycle, capital is likely to become more selective, with fewer borrowers able to access flexible refinancing solutions on favorable terms. For much of the past decade, the rapid growth of the private credit market provided middle-market companies with ample liquidity and borrower-friendly structures, but that dynamic may be shifting amid softening investor appetite for the asset class. While this does not suggest a return to the systemic dislocation experienced in 2008, sustained levels of elevated bankruptcies and more cautious deployment of private credit capital increase the risk that financially constrained middle market companies face limited funding alternatives at critical moments.

Whether private credit’s next chapter is continued expansion into broader investment channels or a period of consolidation driven by credit stress, both paths carry meaningful governance risk. In either environment, D&O insurance remains essential as a practical safeguard against the realities of late-cycle credit risk.

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References:

1. PIK Income Fell Modestly in 2Q25 for BDCs, Dividend Coverage Varies
2. Private-Credit Investors Are Cashing Out in Droves - WSJ
3. https://www.reuters.com/business/private-credit-pressures-fuel-further-defaults-2026-says-morningstar-dbrs-2025-12-16
4. Private Credit Firms Launch New Funds to Attract US Retirement Investors - Bloomberg