What's Going on in Private Credit?

0:01This episode uses an AI reader. This is The Memo by Howard Marks. What's going on in private credit?

0:17The general field called credit has seen massive innovation over the course of my career. Its popularity has increased steadily and its scale and role in the world of finance have multiplied. The other day, an Oaktree colleague asked me about the developments that brought the credit sector to where it is today. I came up with the following list. 1970s. Acceptance of non-investment grade debt. 1980s. Popularization of leveraged buyouts and increased corporate leverage. 1990s. Broadly syndicated loans and tranche securitizations. 2000s, the rising trend toward alternative investments, subprime mortgage lending and mortgage-backed securities.

1:012010s, expansion of direct lending. 2020s, marketing of direct lending vehicles to individual and retirement investors. The investment world I first encountered in the summer of 1968, consisting exclusively of stocks and high-grade bonds, seems quaint and provincial in retrospect, given the developments just listed. These advances have transformed the investment management business, and Oak Tree and its clients have been major beneficiaries. All the changes just listed involved, or were facilitated by, the thing now broadly called credit, essentially non-government debt. I'll lay out a brief chronology to set the scene.

1:39Prior to 1977-78, it was virtually impossible for a company lacking an investment-grade credit rating, jipple beer above, to issue bonds publicly. The speculative-grade debt that did exist was primarily that of previously investment-grade companies that had run into trouble and been downgraded, so-called fallen angels. Companies lacking investment-grade ratings were generally limited to taking out bank loans or borrowing from insurance companies through private placements. Michael Milken is generally credited with the idea, implemented in the late 1970s, that non-investment-grade companies should be able to issue bonds if their interest rates are high enough to compensate for the risk of default.

2:20This kind of risk-return thinking helped enable the development of today's U.S. high-yield bond market of roughly$1.5 trillion, along with most of the other developments under discussion here. A few small leveraged buyouts took place in the mid-1970s, but the popularization of high-yield bonds in the 1980s enabled LBO funds, small companies, and takeover artists to borrow enough money to acquire much larger companies than was previously possible. That led to a massive expansion of LBOs, creating the industry that renamed itself private equity in the 1990s. The idea of pulling debt instruments and selling off tranches with varying seniority, risk, and thus interest rates began with the creation of mortgage-backed securities in the 1970s, most often associated with Louis Ranieri of Salomon Brothers, and expanded in the 1980s and 90s.

3:11Prior to the 1990s, banks made loans, some of them to non-investment-grade companies, and syndicated them to a handful of fellow banks. But then broadly syndicated loans, leverage loans, or senior loans were developed by Wall Street. They were sold to institutional investors in large amounts, growing to today's market of roughly$1.5 trillion in the U.S. The significant increase in the ability to issue this type of financing helped fuel the growth of private equity. After the tech bubble of the late 1990s imploded in 2000, leading to the first three-year decline in the S &P stock index since the Great Depression, investors became uninterested in the stock market and stayed that way for a decade.

3:52And when central banks reduced interest rates to fight the resulting economic and market malaise, investors sought returns above those available on bonds. With stocks and bonds out of favor, investors looked for a new solution. They turned to hedge funds and private equity, which had held up relatively well and the label Alternative Investments was born. Hedge funds couldn't find enough bargain-priced opportunities to accommodate large amounts of institutional capital. So many investors gravitated toward private equity as the solution du jour. The first$10 billion private equity funds were organized.

4:26Around the same time, corporate debt began to be securitized in structured credit vehicles, such as collateralized loan obligations, or CLOs. The banks that packaged these vehicles, with internal leverage from tranching, found eager buyers for both the high-yielding junior classes and the over-collateralized senior classes. The strong demand for CLOs and the profits available from structuring them created a need for loans to securitize, leading to increased issuance of broadly syndicated loans. Many of the same banks packaged subprime mortgage loans extended to questionable borrowers into residential mortgage-backed securities, or RMBS.

5:05Remarkably, the bankers were able to obtain thousands of AAA ratings on RMBS backed by liar loans. When the highly flawed nature of these loans and structures came to light, the result was the global financial crisis of 2008-09. The GFC ended with the banks poorer, chastened, and re-regulated, and as a result, there weren't enough bank loans available to meet the needs of the burgeoning private equity industry. Investment managers moved to fill the vacuum through non-bank lending or private credit. The fastest-growing component was direct lending, private loans to mid-market private equity-sponsored portfolio companies with sub-investment-grade ratings.

5:42Please note, private credit and direct lending aren't synonymous. The latter is a subset of the former. The many stories mentioning private credit these days are really about direct lending. I'll try here to be conscientious about making the distinction. Most who comment aren't. Most recently, it has become popular to market investment vehicles holding direct loans to individual investors in retirement accounts. This increased the capital available for direct lending and ballooned the assets under management of managers who scooped it up. The Normal Pattern

6:17Extreme upsurges in the popularity of novel forms of investment, those commonly labeled bubbles, invariably have certain features in common. The essential element is newness. When something is new, A, it's easy for its proponents to stimulate interest from buyers by touting its merits, and B, since it's never been tested, its flaws have yet to come to light. This allows investment fads to grow into bubbles. Usually, there's a grain of truth. The nifty-fifty were great companies. The internet and digital communication did change the world. And mortgages are usually safe for investment. These truths provided the basis for what eventually grew into highly destructive bubbles.

6:58Early investment in the new thing is often rewarding, since those who get in at the beginning do so at a price that hasn't yet been elevated by rising popularity. The success of early investors makes those on the outside envious, convincing them to join the party. As Charles P. Kindleberger wrote in Manious Panics and Crashes, A History of Financial Crises, there is nothing so disturbing to one's well-being and judgment as to see a friend get rich. Envy just might be the strongest force in the world. The possibility of great success inflames investors' hopes. Possibility is confused with probability and then morphs into certainty.

7:36Skepticism and risk aversion go out the window. The critical question, rarely asked by investors in hot pursuit, is what price is safe to pay to participate? Envy, excitement, the dream of getting rich, and the fear of missing out are the mortal enemies of caution and reluctance to jump on the bandwagon. Latecomers swallow promises, apply low standards, and push up prices, causing most investment trends to become overdone. For me, the most important investment adage of all is, what the wise man does in the beginning, the fool does in the end. Warren Buffett said it more colorfully. First the innovator, then the imitator, then the idiot.

8:14The flaws, potential pitfalls, and unfulfillable promises that investors readily overlook when things are going well invariably lead to disillusionment and loss when the optimism surrounding the new thing turns out to have been excessive, where the prices paid simply turn out to have been too high. When Mark Twain purportedly said history does not repeat itself, but it does rhyme, this must be the kind of recurring pattern he had in mind. I consider it one of the eternal truths in investing.

8:46I think it's fair to say aspects of this progression occurred over the last 15 years in direct lending, a part of the private credit universe. A new form of financing was developed. With banks less willing to lend, the demand for financing from private equity exceeded this supply. That allowed the early direct lenders to demand high interest rates and strong protections through robust loan documents. The low interest rates of the 2010s made the higher prospective returns on direct lending appear very attractive, especially given that returns could be levered through low-cost borrowing. Institutional investors noted the attractiveness of the early loans and joined the party.

9:25No doubt that attractiveness was enhanced by the fact that private loans don't exhibit much price volatility, since there's no market for them to mark two. That might have let their advocates say, they'll deliver high risk adjusted returns, but it wasn't right. They could reasonably have been expected to deliver high volatility adjusted returns, that's what shock ratios are, but I insist strenuously that risk and volatility aren't the same thing. Direct loans embody no less credit risk than liquid credit instruments such as high yield bonds and broadly syndicated loans. It just isn't reflected as readily in prices.

10:00Hundreds of investment firms offered their services in direct lending, the vast majority of which entered the private credit market after the end of the global financial crisis, meaning they'd never been tested in rough times. Regardless, they were given plenty of money to manage. The arrival of many new managers and a great deal of incremental capital caused lenders to compete to make direct loans by accepting lower yields, narrower yield spreads, and reduced safety. Some managers were doubtless motivated to lower the standards in order to put a lot of capital to work. The benign economic and investment environment that generally prevailed during the 17 years since the end of the GFC made direct loans successful, despite signs of weakening underwriting standards, allowing these trends to become more and more pronounced.

10:44The sum of the above facilitated the sale of direct lending vehicles to individual and retirement investors hungry for return in a low interest rate environment. The massive amounts of capital that have been available for investment in direct lending created a gold rush mentality. In the last 15 years, something like$2 trillion of direct loans has been made. The whole private credit sector was only about$150 billion 20 years ago. Thus, I imagine some direct lending managers accepted too much money and invested it too fast, applying standards that were too low and setting the scene for a correction.

11:18In the last several months, the tide has begun to go out for direct lending. generalized to all of private credit by those who don't make fine distinctions. To paraphrase Buffett, this created the possibility that some bare bottoms would be exposed. As I described in my November 2025 memo, cockroaches in the coal mine, two prominent bankruptcies, First Brands and Tricolor, caught credit investors by surprise in mid-2025. Both raised concerns about possible fraud, perhaps enabled by the low standards applied by lenders in good times. This raised some concern regarding public vehicles for direct loans, business development companies, or BDCs.

11:57When some investors in non-traded BDCs wanted to withdraw their money and weren't able to do so in full, questions began to be raised regarding liquidity. Likewise, there were questions about how these vehicles valued their private debt holdings and thus about the accuracy of reporting carrying values and the process of withdrawing from the vehicles. Perhaps as a result, the shares of publicly traded BDCs, which can be sold but not redeemed, came to be priced at wider discounts from their net asset values. The preceding events were mostly treated as idiosyncratic, meaning there was no broad disillusionment or loss of confidence at the time.

12:33But it's usually the case that if a confluence of troubling events builds up, a critical mass can eventually be reached, rendering investors no longer able to overlook the newly exposed flaws in the new thing. And that brings us to software debt. Direct Lending and Software Prior to the mid-2000s, investors in high-yield bonds and leverage loans were generally unwilling to lend money to technology companies, which were considered too fundamentally risky to be creditworthy. And since they couldn't be levered, they were candidates for purchase by private equity funds. But when investment in private equity funds grew strongly, their managers needed companies to buy.

13:13and that caused them to expand the range of what they would consider. They concluded that companies with market-leading positions in essential software that was unlikely to be replaced would A. enjoy the recurring subscription-based cash flows that can make a company bankable and B. benefit from sustainable moats surrounding their businesses. Private equity funds began to buy software companies and credit investors began to lend money for that purpose. In my experience, the limiting factor in the credit markets is never borrower's appetite for capital, but rather lenders' willingness to supply it.

13:47To paraphrase Kevin Costner's character in the movie Field of Dreams, if you provide capital, they'll borrow and put it to work. Thus, the makeup of the credit market was greatly influenced by the growth of private equity, the boom in capital available for direct lending, and both parties' agreement that software companies were good candidates for investment. In recent years, sponsors have increasingly turned to direct lending as an alternative to broadly syndicated loans, as the former allowed them to get the capital they knew from a few big lenders, freeing them from protracted roadshows, widely distributed financial disclosure, and having to deal with a large number of counterparties if trouble necessitated renegotiation.

14:25Direct lenders have also shown a willingness to support higher debt levels, enabling sponsors to achieve leverage beyond what the syndicated loan market might accommodate. They've also been willing to lend more to companies that are not yet profitable in the form of ARR loans based on annual recurring revenue. The attractiveness to sponsors of loans versus bonds and private versus public brought the representation of software debt in the U.S. sub-investment-grade credit markets to roughly the following proportions. High-yield bonds, 4-5%. Broadly syndicated loans, 10-15%. Direct lending, 20-30%.

15:02In addition, thanks to the same factors, the percentage of software debt that is to companies that were the subject of leveraged buyouts, meaning they're more highly levered, is higher in the broadly syndicated loan market than in the high-yield bond market, and higher still in the direct lending market. As a result of all the above, a significant portion of direct loans were made to software companies, which were often acquired at high EBITDA multiples of around 20x and with high leverage ratios. Now, suddenly, software company DAT is in the news. Over the last year or two, artificial intelligence has significantly reduced the need for humans to write code.

15:40That is, program computers or write software, largely relegating coders to instructing AI models what to do. The market for software company stocks and debt didn't react much in 2024-25. Then, in November 2025, Anthropic released a powerful new model for coding, followed in late January by the release of 11 plugins to automate tasks in a number of fields. It seems a cognitive tipping point was reached in the first days of February. Investors finally took notice of the negatives that had accumulated, and the private credit market has faced scrutiny and volatility ever since. Worry about software debt made investors in semi-liquid public vehicles put in for redemptions.

16:23Limits on redemptions caused investors to question the safety of their investments. The process through which some investors got out at the stated net asset value might have caused those remaining to question whether the NAVs people exited at were overstated and if so, what the impact might be on them. When funds limited redemptions, investors might reasonably have concluded that they should put more shares in for withdrawn next time. The redemption limits built into the direct lending funds appear to have worked as designed so far, allowing managers to avoid fire sale liquidations. But it would be understandable if investors reacted negatively to being told they can't get their money out when they want.

17:03Private Credit and Public Investors There are two different things going on in private credit today. There are the developments in the fundamentals of borrowers and the solidity of loans, and then there are the reactions of investors. As Armin, Bob, and Craig wrote in a recent internal memo, While these software companies are generally performing well with a few outliers, there has been a growing concern in the market that they are at risk of significant disruption from AI, which has materially impacted their equity value and reduced the equity cushion for lenders. Today, investors are not discriminating between the potential winners and losers in the software space and the entire sectors under pressure.

17:43The disruptions and headlines are largely flow and sentiment-driven rather than the result of credit deterioration. Investors are rarely the informed, methodical, dispassionate weighing machine Benjamin Graham and David Dodd described in security analysis, and certainly not in the short one. As I wrote in my 2016 memo, What Does the Market Know? In real life, things fluctuate between pretty good and not so hot. But in the minds of investors, they go from flawless to hopeless. Investors initially fall in love with the new thing, swallow its promises whole, and overpay. Optimism and excitement are never conducive to skepticism, dispassionate analysis, the maintenance of appropriate risk aversion, and the insistence on high standards.

18:28Then, when disappointment and disillusionment set in, the bravado and confidence that originally supported the investment evaporate. Now the analysis errs in the opposite direction, with excessive pessimism and skepticism replacing eagerness and gullibility, and with sheer terror replacing the blind fate that enabled investment when everything was going well. The implications of AI for the software industry, limitations on liquidity in private assets, and uncertainty regarding the accuracy of direct lending funds pricing had been there for years. But, simply put, people may not have asked enough questions or paid enough attention in the good times, as usual.

19:06This has led to the current discomfort of investors in direct lending vehicles. Individual investors in a new phenomenon like direct lending are unlikely to fully grasp its potential complications, especially if it has never been seen in action during tough times. The inclusion of leverage in the vehicles may have been touted as profit-enhancing, and now investors are seeing it at work in the opposite direction. And the investment vehicle's limitations on liquidity, which may have been glossed over with representation that, most of the time you'll probably be okay, has come into play with surprising effect.

19:39True believers make the most money in manias, and skeptics lose at least when they crash. But the key to the investment success we aim for lies in always maintaining a healthy balance between belief and doubt. As Charlie Munger used to say, quoting the ancient philosopher Demosthenes, for that which a man wishes, that he will believe. Most people dream of getting rich and are willing to trust when promised a way to do so without risk. But the new thing rarely pays off as expected, especially if invested in unskeptically while it's raging. It's safest to stick to tried and true investments and leave the more innovative developments to experts who are able to understand and cope with the implications.

20:18But few can resist the siren song of easy profits that accompanies most untested fads. It will ever be so. The Lessons of 1929 The best investing book I've read in years, one that pulled me along from chapter to chapter, is 1929, Inside the Greatest Crash in Wall Street History and How It Shattered a Nation, by Andrew Ross Sorkin. It describes a lead-up to the great crash of October 29, 1929 and its aftermath. And it does so not by dryly recounting the events, but through profiles of the protagonists of the day. There are a lot of lessons to be learned from 1929, along the lines of my favorite books about market excesses, A Short History of Financial Euphoria by John Kenneth Galbraith, 1994, and Devil Take the Hindmost, A History of Financial Speculation by Edward Chancellor, 2000.

21:11My take from 1929 was that three things in particular were primarily responsible for the bubble that ended in the Great Crash. The sale of stock to the public without regard for suitability. The provision of heavy leverage to the buyers. And the mismatch between the illiquidity of the assets bought and the short-term nature of the loans that financed the purchases. Individual investors were lured into the stock market, following an ascent that had gone on for years. The major stock market averages had already risen by roughly 400 % between 1921 and 1928. Brokerage firms hungry for commissions and markups on larger transactions provided margin loans for up to 90 % of the purchase price.

21:55And those loans could be called and the position sold out if a decline wiped out the investor's 10 % equity and additional cash couldn't be posted. The story sounds familiar and has been repeated several times since. A lack of financial sophistication on the part of individual investors leaves them susceptible to promotions and too-good-to-be-true promises. Leverage is described as capable of magnifying the fruits of success, but the corresponding downside risk is often omitted from the sales pitch. The perhaps unmentioned terms of margin debt and the difficulty of imagining the full depth of potential market decline expose investors to the risk of ruin.

22:36It's not easy to lose everything in the stock market, but the combination of these three elements can do the trick in a bad enough boom-bust cycle. The things just described took place in 1929 against the background of a near-total absence of laws governing the investment business, including requirements for honesty and prospectuses, and were compounded by the self-serving delusion, lack of principles, and downright venality of some Wall Street leaders. The result was a market and economic catastrophe that scarred several generations. Sorkin mostly limits himself to chronicling his character's behavior, leaving the drawing of conclusions and morals until the very end, but he finishes with a punch.

23:18The devastation wrought by the stock market's decline, not just during the crash itself, but for most of the ensuing decade, caused millions of Americans insufferable pain. It caused them to not just turn away from the market, but to revile those who made their living buying and selling stocks. Yet the forces that drove the market to such stratospheric levels, optimism, ambition, and the belief that the future could be endlessly brighter, did not disappear forever. They never do. Ultimately, the story of 1929 is not about interest rates or regulation, nor about the cleverness of short sellers or the failures of bankers.

23:56It is about something far more enduring, human nature. No matter how many warnings are issued or how many laws are written, people will find new ways to believe that the good times can last forever. They will dress up hope as certainty. And in that collective fever, humanity will again and again lose its head. The enduring lesson is not that booms can be prevented or that busts can be fully averted. It is that we need to remember how easily we forget. The antidote to irrational exuberance is not regulation by itself, nor skepticism, but humility. The humility to know that no system is foolproof, no market fully rational, and no generation exempt.

24:36The greater the heights of our certainty, the longer and harder we fall. Sorkin's concluding observations capture the lessons that can be learned from the mistakes that rhyme from cycle to cycle. What's a manager to do? In my opinion, perhaps the conscientious manager's biggest problem arises when too much capital is being pushed into their market and investors are too eager to put it to work. I talked about this at length in my February 2007 memo, The Race to the Bottom, on the doorstep of the global financial crisis. I can't believe it's almost 20 years old. That's roughly when Citibank's CEO, Chuck Prince, was moved to say, As long as the music is playing, you've got to get up and dance.

25:21What a choice for a manager. Join in when feverish investors are lowering their standards in order to put money to work or sit on the sidelines and not invest, watching as other managers pile up AUM and likely causing clients to close their accounts in the seemingly interminable period before your skepticism and discipline finally pay off. I never want to present Oak Tree Brookfield as the paragon of investment virtue, and I never say we're perfect. However, superior investing doesn't result from omniscience and perfect decision-making, but rather from decisions that are better than those made by others.