Things Go Wrong In Credit
Ask A CIO #55
It’s not usually a good sign when a credit investment shows up in the news. After all, when things go well, credit is rather dull (in a good way). Bonds are issued, interest is paid, debt is retired. Broadly speaking, the better the company, the more boring the credit.
When a credit story shows up in the news, it’s almost always because a bad thing has happened. And lately, there have been a lot of credit stories in the news.
In fairness, some stories have been more observational. Say, perhaps, those of certain hyperscalers issuing bonds and getting a little creative with their financing measures.
Then there are the other headlines… Tricolor, First Brands, Renovo, Broadband Telecom, a cluster of bad loans at regional banks.1 Now these stories have been exciting (though not in a good way). They offer cautionary tales, detailing sudden collapses in value, accusations of fraud, and plenty of finger pointing.
Which brings us to this week’s topic. I received several questions all along a similar theme, so I’ll take the liberty of paraphrasing.
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How concerned should investors be about credit markets generally, and private credit specifically?
When I see questions like this, my reflexive reaction is – well, yes of course, investors should always be a bit paranoid when it comes to credit.
But I also recognize that, in light of recent events, everything feels more fragile.
Before we dive in further, it’s worth noting that several of the recent major credit stories contained significant elements of fraud. Are there potentially other cases of fraud that could be revealed in the coming months? If I had to guess, I’d say yes. But any given case of fraud tends to be idiosyncratic, so I’ll refrain here from speculating on the likelihood of other cases showing up.
In some ways, asking how worried one should be about credit markets is much like asking how worried one should be about the stock market. One answer might be: like the stock market, U.S. credit markets are expensive relative to historical averages, as measured by spread premiums.
Take for example, investment grade corporate bonds, which as of yesterday are offering on average 85 bps of excess return in exchange for taking on the additional credit risk over Treasuries. Or high yield corporate bonds, which as of yesterday are offering on average an excess return of just over 300 bps above Treasuries.2
In conversations with managers, I’m hearing that leveraged loans are pricing at SOFR plus low to mid 400s. And anecdotally, first-lien unitranche private credit deals have been getting priced around SOFR plus 550 bps, and in some cases, below 500 bps.3
To those readers for whom the above sounds like gibberish, the takeaway here is that credit markets have been expensive for some time. We have been in an environment that offers higher base rates but increasingly compressed spreads. Not only are credit spreads low relative to risk free rates, but they are compressed relative to each other. In other words, the additional return generated for moving up each rung on the risk ladder is uncomfortably low.
In a balanced market, spreads should adequately compensate investors for taking on incremental credit risk. It would appear, however, that we have not been in a balanced market.
Instead, this is a market in which, for lack of a better description, there is a lot of capital sloshing around out there that needs to be put to work. And for various reasons, there hasn’t been as much primary issuance and new supply (e.g., fewer transactions in private equity means fewer loans issued). I’m oversimplifying here, but where there is more demand than supply, pricing goes up. That’s the state of the market, and the recent credit stories, though headline-grabbing, do not appear to have made much of a dent on the overall conditions described above.
All that said, I want to point out that I was also being serious in my initial response. I meant it when I said that investors should always be a bit paranoid when it comes to credit. Not just in the moments when credit headlines grab our attention.
In my experience, investors often underappreciate risk in credit investments. Unlike equity investments, which carry unlimited upside, credit investments have capped upside. In the very best scenario, investors earn their contractual yields and return of capital. In the worst outcome, investors can suffer total wipeouts.
This lopsided return distribution means that mistakes in credit portfolios are more costly. There is less upside available across a credit portfolio to make up for losses that might occur. To state the obvious, when investing in credit, it’s important to select managers with strong underwriting capabilities.
But that often isn’t enough. Even managers with the best credit underwriting processes are still likely to experience defaults at some point over the life of their funds. Things happen. Companies and investments can go sideways for a myriad of unforeseeable reasons. Who predicted a global pandemic in 2020? Risk management, which is always important, is that much more so in credit investing.
Everything we’ve discussed so far pertains to credit markets generally, but I do think it’s appropriate to acknowledge that there are also challenges specific to private credit. Although the most prominent recent failures, Tricolor and First Brands, arguably occurred in public market securities (i.e., Tricolor issued ABS and First Brands issued leveraged loans), the losses and recriminations extended to private credit.4
Witnessing the collapse of Tricolor and First Brands in public markets brought to the forefront concerns around the lack of transparency and price discovery in private markets. What is the risk that private loans are not accurately priced? And how widespread might that risk be? It is decidedly not a good look to have certain stressed loans marked at dramatically different valuations across private credit firms.5
I’m inclined to think that, as with all other asset classes and strategies, there is wide variation in manager quality. I fully suspect there are managers carrying questionable marks out there. But there are also managers that have been more conservative around structuring, documentation, and terms.
And should things go wrong, which they inevitably will from time to time, those credit managers with deep workout experience and the ability to navigate restructurings are likely to offer their investors a very different outcome.
Thanks for the questions! As always, please reach out: askacio@ivyinvest.co.
See you in two weeks,
Wendy
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“Tricolor collapse sparks concern about health of US subprime auto sector,” Financial Times, September 15, 2025.
“Watch for This Toxic Trifecta Before the Next Financial Meltdown,” Bloomberg, November 14, 2025.
“Bankrupt Telecom Business Accused of Fraud in Receivables Financing,” Wall Street Journal, October 22, 2025.
Ice Data Indices via Fed Reserve Bank of St. Louis: Investment Grade and High Yield option adjusted spreads
These data points and this newsletter’s overall discussion are focused on the direct lending part of private credit.
Notably, First Brands extensively engaged with private credit lenders for off balance sheet inventory and supplier financing. Certain private credit funds also held its publicly traded loans.
“Apollo, KKR See Record-Wide Gap on Valuing Stressed Private Loan,” Bloomberg, November 13, 2025.