Are We Seeing Cracks or Is There Still Opportunity?

Written By Sloan Smith, MBA, CAIA, CPWA®

In the fall of 2025, the bankruptcies of Tricolor Holdings and First Brands Group drew significant attention across private credit markets. Tricolor, a subprime auto lender, was accused of pledging the same loans multiple times, ultimately liquidating with over $1 billion in outstanding debt. First Brands, an auto parts manufacturer, collapsed following allegations of capital misappropriation and complex off-balance-sheet financing arrangements.

The resulting headlines prompted creditors and market participants to increase regulatory scrutiny and reinforce due diligence practices. A prevailing concern emerged that instances of fraud may not be isolated, but rather indicative of loans in the broader private credit market. However, during these times of potential distress, private lenders who structured loans that reside high in the capital structure (i.e., they are first to be paid back, in the event of a default) and are backed by the collateral of an underlying business were mostly protected from any significant disruptions in the greater private credit landscape.   This dynamic demonstrated the value of owning senior-secured, collateral-backed loans due to their greater protection against issues such as defaults. Also, many private lenders issuing these types of loans had strong underwriting requirements and were not interested in First Brands and Tricolor due to their concerning financial situations. Though headlines raised alarm about the greater private credit space, it is important that investors remember the benefits of owning these types of loans in the capital structure. They are not only senior-secured and collateral-backed, but also provide attractive yields and inflation protection due to their floating-rate nature. Ultimately, these unique components continue to make this area of the private debt asset class attractive, especially going forward.

The advantages of senior-secured, first-lien loans

The landscape for private debt has evolved, but senior-secured loans continue to offer the following benefits:

1.       Risk Mitigation

Private debt offerings most commonly take the form of senior-secured, first-lien loans, which occupy the highest priority position in a company’s capital structure. This means the lender holds a primary claim on specific collateral, such as buildings, inventory, or accounts receivable, that backs the loan. In the event of borrower default, the lender has the legal right to seize these assets before other creditors are paid, significantly reducing the risk of loss. This structure offers a more secure investment than subordinated or mezzanine debt, which is generally unsecured and ranks lower in the capital hierarchy, just above equity.

2.       Sponsor Backed

Senior-secured private credit continues to appeal to investors because of its unique structure and the alignment of interests it fosters between lenders and borrowers. Lenders often work directly with borrowers, often private equity companies or “sponsors,” which encourages thorough due diligence and ongoing monitoring. This close relationship frequently results in stronger covenant protections and more customized loan agreements, allowing lenders to manage risk better and respond proactively to any signs of borrower distress.

3.       Attractive Yields and Hedge Against Inflation

Another key attraction is the yield premium that senior-secured private credit offers. Investors are compensated for accepting less liquidity compared to public markets in return for higher yields. This “illiquidity premium” has been a consistent source of attractive, risk-adjusted returns, especially in environments where traditional fixed income yields are relatively low. Currently, the annual yield in senior-secured private credit ranges from ~8% to ~10%, which is higher than public equivalents, such as leveraged loans and high yield bonds. Additionally, a majority of private debt is issued as floating- or variable-rate. If inflation were to persist and interest rates were to rise, the yield on private debt would adjust accordingly.

4.       Better Covenants and Underwriting

Over the last fifteen years, during a more accommodative, lower interest rate environment, terms of private loans were more favorable to borrowers. Structures such as delayed draw term loans (DDTLs), which permit borrowers to draw additional funds during the term of the loan, became more prevalent. However, in the current landscape, lenders are demanding higher rates and improved terms. This has allowed senior-secured private debt investors to oversee their underlying portfolio companies better and take the necessary corrective action.

The most significant area of concern in private debt is defaults. While senior-secured private debt offers an attractive investment opportunity in the current market environment, the risk of default remains one of the greater headwinds in the asset class. Longer-term and legacy private debt issuers face risks of higher interest rates, which makes servicing debt more difficult, a potentially slower economy, and margin erosion. If the United States were to experience a severe recession, private debt portfolios would be negatively impacted.

The bankruptcy of First Brands and Tricolor raised significant concerns in the lending market. However, senior-secured, collateral-backed loans remained sound due to their tighter covenants and underwriting standards. Additionally, these loans continue to offer high yields, inflation protection, diversification, and the additional provision of being high in the capital structure. While idiosyncratic and recessionary default risks remain present in this asset class, senior-secured private debt continues to offer the potential for more favorable risk-adjusted returns, particularly when compared to public equities and fixed income. In an uncertain time in the markets and economy, private debt can still benefit a portfolio through diversification and total return while minimizing risk.

Figure 1: Private Credit’s Wall of Worry

Growth of $1 in the Private Credit Space since September 2019

Source: Cliffwater

This article was developed collaboratively, with contributions from Peter Girard.