No cockroaches in private debt

Direct lending, the largest segment of the private debt market, is showing continued strength. If risk is defined as getting your principal back at maturity, recent reporting from BDCs and interval funds suggests that investors can largely ignore the colorful headlines. Vigilance is a necessary constant in an asset class that only has downside risk, but private debt executed by serious players continues to produce attractive short- and long-term risk-adjusted returns for investors.

The thing about cockroaches is that if you find one, there are thousands lurking. And where you find cockroaches, other pests are to be found. In finance, that imagery translates into systemic risk.

Systemic risk is much less likely in private debt compared to broadly syndicated (bank) loan market. Why?

1. Private debt lenders hold the loans they originate to maturity. Banks originate loans but then sell those loans through broad syndication, collecting fees but offloading default risk to investors. Banks lack incentives to “just say no” to bad loans.
2. Bank loans (aka broadly syndicated loans or “BSLs”) lack covenant protections against cockroaches that most private middle market loans possess.
3. Broadly syndicated loans are less likely to be private equity sponsored, making their debt more susceptible to weak management and fraud.
4. Broadly syndicated loans in workout are likely to see greater value destruction due to possible subordination strategies used by the entry of specialized distressed investors, in contrast to private middle market loans where private equity borrowers and private debt lenders are more likely to seek value-preserving loan restructuring.
5. Almost one-half of broadly syndicated loans become part of highly levered collateralized loan obligations (CLOs) where problem loans can put price pressure on other loans in efforts to de-lever.

The recent First Brands default, a $4.4 billion hit (30 basis points) to the Morningstar LSTA US Leveraged Loan Index, epitomizes the underwriting weakness found in the broadly syndicated loan market. In this case the banker (Jefferies) appeared to be more interested in deal fees than due diligence.

In an interesting twist, the Tricolor default likely quiets those firms that recently touted asset-backed financing as the next best thing to direct lending. A bank-led subprime auto loan deal, this underwriting debacle appears to have created large losses for a few banks, including J.P. Morgan, and some large asset managers exposed through securitized asset-backed securities (ABS) structures. Undoubtedly, asset-backed loan investors are wondering if these two underwriting failures reflect something systemic across banks.

Casting fear upon private debt has been a hobby for bank executives, the business press, and a few policymakers for several years now. None of these concerns have materialized. Our narrative has been consistent. The private debt market brings together sophisticated lenders (asset managers) and borrowers (private equity sponsors) that exhibit a strong alignment of interests to the benefit of investors that are willing to forfeit some liquidity in exchange for a higher yield and possibly better underwriting (lower defaults) by accessing high-quality lenders.

This piece was written by Stephen Nesbitt, CEO of Cliffwater.

Disclaimer:See “Dimon’s ‘Cockroach’ Fear Revives Threat of Cracks in Credit.” Bloomberg, October 14, 2025.The views expressed herein are the view of Cliffwater LLC (“Cliffwater”) only through the date of this report and are subject to change based on market or other conditions. All information has been obtained from sources believed to be reliable but its accuracy is not guaranteed. Cliffwater has not conducted an independent verification of the information. The information herein may include inaccuracies or typographical errors. Due to various factors, including the inherent possibility of human or mechanical error, the accuracy, completeness, timeliness and correct sequencing of such information and the results obtained from its use are not guaranteed by Cliffwater. No representation, warranty, or undertaking, express or implied, is given as to the accuracy or completeness of the information or opinions contained in this report. This report is not an advertisement, is being distributed for informational and discussion purposes only, should not be considered investment advice, and should not be construed as an offer or solicitation of an offer for the purchase or sale of any security. The information herein does not take into account any investor’s particular investment objectives, strategies, tax status or investment horizon. Cliffwater shall not be responsible for investment decisions, damages, or other losses resulting from the use of the information. This report is not intended for public use or distribution. The information contained herein is confidential commercial or financial information, the disclosure of which would cause substantial competitive harm to you, Cliffwater, or the person or entity from whom the information was obtained, and may not be disclosed except as required by applicable law.The information in this report is not intended as a recommendation to invest in any particular asset class or strategy or as a promise of future performance. Note that these asset class and strategy assumptions are passive only, and they do not consider the impact of active management. References to future returns are not promises or even estimates of actual returns a client portfolio may achieve.Statements that are nonfactual in nature, including opinions, projections and estimates, assume certain economic conditions and industry developments and constitute only current opinions that are subject to change without notice. Further, all information, including opinions and facts expressed herein are current as of the date appearing in this report and is subject to change without notice. Unless otherwise indicated, dates indicated by the name of a month and a year are end of month.There can be no assurance that any expected rates of return or risk will be achieved. Expected rates of return and risk are subjective determinations by Cliffwater based on a variety of factors, including, among other things, investment strategy, prior performance of similar strategies, and market conditions. Expected rates of return may be based upon assumptions regarding future events and conditions that prove to be inaccurate. Expected rates of return and risk should not be relied upon as an indication of future performance and should not form the primary basis for an investment decision. No representation or assurance is made that the expected rates of return or risk will be achieved.This report may include sample or pro forma performance. Such information is presented for illustrative purposes only and is based on various assumptions, not all of which are described herein. Such assumptions, data, or projections may have a material impact on the returns shown. Nothing contained in this report is, or shall be relied upon as, a representation as to past or future performance, and no assurance, promise, or representation can be made as to actual returns. Past performance is not indicative of future returns, which may vary. Future returns are not guaranteed, and a loss of principal may occur.Cliffwater is not sponsored, endorsed, sold or promoted by Morningstar, Inc. or any of its affiliates (all such entities, collectively, “Morningstar Entities”) or the Loan Syndications and Trading Association (“LSTA”). The Morningstar Entities and LSTA make no representation or warranty, express or implied, to the owners of Cliffwater or any member of the public regarding the advisability of investing in leveraged loans generally or in Cliffwater in particular or the ability of Morningstar LSTA Leveraged Loan Index to track general leveraged loan market performance.THE MORNINGSTAR ENTITIES AND LSTA DO NOT GUARANTEE THE ACCURACY AND/OR THE COMPLETENESS OF THE MORNINGSTAR LSTA LEVERAGED LOAN INDEX OR ANY DATA INCLUDED THEREIN AND HAVE NO LIABILITY FOR ANY ERRORS, OMISSIONS, OR INTERRUPTIONS THEREIN.Cliffwater is a service mark of Cliffwater LLC.Betashares Capital Ltd (ABN 78 139 566 868 AFSL 341181) (Betashares) is the issuer of the Betashares Funds, as well as Betashares Invest, the IDPS-like scheme available through Betashares Direct. Before making an investment decision, read the relevant Product Disclosure Statement, available at www.betashares.com.au for the Betashares Funds or www.betashares.com.au/direct for Betashares Invest. You can also obtain a copy of any Betashares disclosure document by emailing Customer Support at [email protected]. The Fund is available to wholesale investors, and other investors with a financial adviser using an investment platform. It may suit investors who are seeking income and capital preservation from an allocation to private credit, and who have a medium risk and return profile for that portion of their investment portfolio. Investors must be comfortable with the risks associated with private credit, including exposure to an asset class that is inherently illiquid and limited ability for investors to withdraw their investment. A minimum investment timeframe of 5 years is suggested. There are risks associated with an investment in the Fund, including liquidity risk, interest rate risk, leverage risk and credit risk. Investment value can go up and down. An investment in the Fund should only be considered as a part of a broader portfolio, taking into account your particular circumstances, including your tolerance for risk. In preparing this information, Betashares has relied on, without verification, data sourced from external parties. Betashares does not warrant the accuracy or completeness of this information.