Private Credit’s Liquidity Illusion

Among PE sponsors, 60% flagged illiquidity as the primary concern in today’s booming private credit market. Consultants were nearly as blunt at 57.1%. Bankers, in contrast, were more evenly split—dividing their concerns between rising borrower default rates (34.7%) and illiquidity (34.7%), with another 30.6% worried about loose underwriting standards.

On average, 40.9% of all respondents ranked illiquidity as the #1 risk, making it the most commonly cited threat across the board.

Why it matters:

Private credit is no longer a niche strategy—it’s a $1.6 trillion asset class fueling everything from middle-market buyouts to mega-LBOs. But behind the yield premiums and bespoke structuring lies a structural tension: these loans rarely trade. In benign environments, that opacity looks like insulation. In a downturn, it starts to look like a trap.

Default risk can be priced. Underwriting standards can be tightened. But liquidity—when gone—is gone. Even for seasoned PE sponsors, the fear isn’t just mark-to-model valuation gaps; it’s the inability to act when markets seize up.

GPs know this. That’s why they’re first to raise the red flag.

The irony? Many of the same GPs raising alarms are simultaneously expanding private credit platforms, launching NAV loans, and layering on continuation funds—all mechanisms that extract liquidity without resolving fundamental exit risk.

Consultants, meanwhile, likely see the systemic exposure. As more institutional portfolios overweight private credit, consultants are left to manage allocation risks with no real-time price discovery or liquid fallback.

Bankers’ split view, with a surprisingly high concern for borrower defaults, may reflect their proximity to deal origination and underwriting. While some market observers argue that “loose standards” peaked in 2021–2022, structures like PIK toggles and covenant-lite terms remain widespread.

The Bottom Line

Private credit’s greatest strength—long-duration, customized capital—is also its Achilles heel when liquidity dries up. As fundraising stays hot and credit spreads tighten, it’s easy to forget that risk-off markets tend to punish complexity and reward simplicity. In the next downturn, the ability to offload a syndicated loan may look enviable compared to holding a bespoke direct lending tranche with zero secondary bids.

For now, returns are strong and defaults low. But when the cycle turns, the market will relearn an old truth: Yield is optional. Liquidity is not.