Navigating the turbulence in private credit

If 2024 was the year of the private credit boom, then 2025 is shaping up as the year for lenders to take stock and be more nuanced with their view of risk. In every credit cycle boom there is more funding available for every worthy borrower, leading to favourable pricing and terms offered by lenders. Often, in a chase for higher returns, credit providers will then lend to riskier borrowers to maintain higher interest rates. As a result, often too much money flows to marginal borrowers and opportunities. 

As the economic cycle turns, some of these marginal opportunities turn sour and pain is experienced by business owners and, in a rising number of cases, their lenders.  

The price of risky loans 

Prior to 2010, many banks found themselves chasing marginal borrowers and when the economic shakeout occurred, some banks got into trouble. This last occurred during the Global Financial Crisis (GFC), and some of these banks failed, never to return. In this cycle, the banks generally have maintained a more restrained credit appetite and have instead prioritised growing their residential lending portfolios off the back of booming house prices. 

For commercial loans, especially for property development, construction and higher-risk corporate loans, the banks have apparently been willing to forgo chasing the growth, creating a gap in available credit. Private credit funds have largely filled this over the last few years. 

Against a largely unregulated lending environment, these private credit funds have been more than willing to fund a surge in demand, even with higher risk profiles, charging higher interest rates and fees. Investors in private credit funds have been more than happy to pick up the double-digit returns typically on offer. 

While credit remained readily available and asset prices held up, debts with high interest rates could be repaid or refinanced easily. Borrowers repaid loans, and private credit fund investors happily reinvested. 

In this cycle, we’ve started to see cracks appear for the first time. Over the last quarter of 2024 and in the first few weeks of 2025, reports have come to light of private credit funds re-assessing their loans against the backdrop of a rise in defaulting borrowers. Some of the funds have been transparent about the issues within their loan portfolios, while others have been less so.  

Does this mean some private credit funds have gone too far up the risk curve at a time when the economic cycle was turning? 2025 will likely be the year we find out. 

Heightened borrower refinance risk 

The damaging result of the downturn during the depths of the GFC was the sharp pull-back in the availability of credit for all borrowers, even those that were considered strong and low risk. Lenders became more concerned with the repayment risks of their borrowers, which were generally reinforced by an increase in bad debts. At the same time, faced with the prospect of lower future returns, fewer equity investors were willing to increase their exposure to the banking and finance sector. As a result, lenders started to conserve their capital, seeking to shrink their portfolios. 

This pull-back in appetite caused a domino effect, curtailing the availability of credit more broadly, which then had a negative impact on asset prices. As some asset class prices turned down, lender appetite evaporated even faster. 

Strong borrowers who had previously enjoyed the easy flows of available credit suddenly found themselves with a significant refinance risk at the maturity of their loans. Lenders who needed capital returned to provide a buffer for bad debts identified any loan coming up for maturity as a source of additional capital. Some lenders appeared to look for any available technical breach as a reason to call in the loan early. Perversely, some borrowers with the strongest credit risk rating seemed to be targeted - as their lenders knew these borrowers had a higher chance of refinancing or undertaking an asset sale that could deliver the loan repayment. 

Borrowers who hadn’t properly protected themselves with a set of covenants providing adequate headroom and a long maturity profile found themselves at risk. Borrowers who long believed they were in a comfortable position and enjoyed the lower cost of short-dated loan terms or at-call loans found there was a very real liquidity cost to be paid for this benefit. 

Borrowers who maintained their discipline and properly managed refinance risks were able to ride out the storm. 

How can you manage your position? 

As we enter 2025, our experts anticipate a period of tightening credit availability. While the hot money poured into private credit in 2024 this will likely moderate as investors increasingly demand greater transparency on loan portfolio performance, bad debts and shifting security valuations. As a result, some private credit funds will find themselves looking to call in more loans to manage their capital in the face of diminished new capital inflows.  

Regardless of the lender, borrowers can take a couple of steps to protect themselves. 

Strategies for borrowers to navigate the 2025 private credit landscape

Our experts recommend borrowers refresh their memory of the key loan terms and conditions. A good first step is to review the loan facility documentation to identify key covenants and areas where a potential breach may occur, giving the lender a chance to accelerate debt repayment obligations. Identifying the key terms that pose the highest risk to your business will highlight what you need to negotiate with your lender before a breach occurs. 

Any borrower with a maturity within the next six months should start considering their refinance requirements immediately. Those with a maturity between June and December this year should also get proactive. Identifying the lenders that have an appetite for your loan can also provide alternative avenues to pursue if you find yourself having difficulty with your current lender. 

Ensure you’re well prepared for any refinance risks ahead. BDO’s debt advisory team can assist you in running a refinance process and reviewing loan facility documentation to identify likely risks. We also have extensive experience helping businesses in distressed debt scenarios.