Private Credit for when Rates Rise and Banks Retreat
Key Highlights
Interest rates remain “higher for longer” while banks tighten lending, forcing businesses to explore alternative funding options.
Private Credit is now a $3T+ market, private credit is stepping in with flexible capital. Low default rates (~2–4%), help companies stay afloat.
Companies are using private credit to stabilise cash flow, fund M&A or growth, and avoid equity dilution. Faster and more tailored than bank loans.
You can blend bank and private capital, but need to manage leverage carefully. Work with international private credit experts to easier access the over $300B “dry powder” sitting with lenders, globally.
With continued private credit expansion, and easing (but still elevated) rates, well-prepared companies can grab an opportunity to support growth.
Introduction
High interest rates are sticking around, banks are getting stingier with loans, and corporate defaults are creeping up.
For business leaders, it’s a worrying mix.
In the US, the average default risk for public companies hit 9.2% at the end of 2024 – the highest since the financial crisis, reflecting the strain of a prolonged period of elevated rates.
Bank lending has simultaneously pulled back as institutions face tougher regulations and economic uncertainty, leaving many firms scrambling for capital.
Yet amid this storm, private credit – loans from non-bank investors – is emerging as a crucial lifeline. Once a niche “alternative” funding source, private credit has gone mainstream: global private credit assets under management (AUM) now top $3 trillion, a tenfold expansion since 2009.
Industry leaders are even calling this a “golden moment” for private debt, as high yields and strong investor demand position private lenders to fill the financing gap left by banks. The big question for companies is how to harness private credit to weather today’s challenges and fund tomorrow’s growth.
We take a macro view of the financial landscape – from rising defaults to “higher-for-longer” interest rates – and explore why these headwinds are creating opportunity for businesses savvy enough to leverage private credit. We’ll also offer practical tips on using private credit strategically to stabilize operations, drive growth, and avoid diluting equity ownership, all while keeping an eye on risk. Let’s dive in.
Higher Rates, Rising Defaults, and Tight Credit: A New Financing Landscape
Interest rates are high – and likely to stay that way for now.
After aggressive rate hikes to combat inflation, central banks have only just begun tentative easing. Even with some cuts expected in 2025, rates will remain well above the rock-bottom levels of the 2010s.
In fact, analysts expect no quick return to pre-pandemic near-zero rates. This “higher-for-longer” rate regime means borrowing costs are elevated for anyone seeking capital.
For businesses, that translates to pricier loans and bonds, squeezing interest coverage ratios and straining balance sheets. Companies that binged on cheap debt in years past now face refinancing at much higher yields, a painful adjustment.
It’s no surprise that corporate default indicators are flashing warning signs – Moody’s measures of default risk hit post-2008 highs in late 2024. Yet, so far actual defaults (especially in private credit portfolios) have remained lower than many expected.
What rising corporate defaults mean for you.
Despite widespread fears, default rates in mid-market private loans have stayed in the low single digits (around 2–4%).
How is that possible in a high-rate environment? One reason is that many borrowers and lenders have been proactive in managing the stress.
Companies benefited from strong post-pandemic earnings and cost-cutting that bolstered their cash flows. Private lenders also showed flexibility – for example, 2024 saw increased use of payment-in-kind (PIK) interest, allowing borrowers to conserve cash by paying interest with additional debt.
These measures provided short-term relief and helped avert defaults. (Notably, we shouldn’t assume PIK loans always signal distress; they can be a tactical tool, though overuse can pose longer-term risks.) Moreover, many private loans lack the mark-to-market volatility of public bonds, so companies have been able to quietly extend maturities or amend terms without triggering a formal default.
As one industry veteran quipped, “the innovation around thwarting price discovery has been extreme”, meaning lenders have gone to great lengths to avoid recognising losses. In short, headline default stats may be the tip of the iceberg, with some stresses lurking beneath the surface.
Lenders and rating agencies often don’t formally acknowledge a bad loan until very late in the game, so today’s low default rates should be viewed with cautious optimism.
Why traditional lenders are pulling back.
Banks, especially in the US and Europe, have become more selective about lending to all but the strongest corporate borrowers.
This credit tightening is driven by multiple factors:
· Regulators are imposing stricter capital rules (Basel III “endgame” reforms) that make certain loans less attractive for banks to hold,
· A few high-profile bank failures have increased wariness of risk, and
· The economic outlook remains uncertain with ongoing geopolitical tensions.
The result is that many companies – particularly mid-sized firms or those with any hint of cyclicality – are finding their banks less willing to extend credit.
In Asia, for instance, an uptick in defaults in 2024 led traditional banks to pull back from higher-risk loans, leaving private lenders to step in as a “robust pillar” of financing.
This pattern holds globally: since 2008, banks have steadily reduced their corporate lending exposure (unable to satisfy surging credit demand due to regulatory constraints).
Astonishingly, in the US banks and securities firms provided over 70% of corporate loans in 1994, but by 2020 that share fell to just 10% – the rest is now filled by private markets. In Europe and other regions, bank lending is also giving way to private credit funds, especially for leveraged finance and special situations.
For business leaders, this shifts the financing landscape.
Instead of one-stop financing from your relationship bank, you may need to tap into the private capital markets for funding. The good news is that private credit has ample capacity and appetite to lend.
Years of growth have turned private credit into a massive capital pool – by the end of 2024 the global private credit market exceeded $1.5–$2 trillion in AUM (depending on the measure), and as noted earlier, broader definitions put it above $3 trillion.
Investors from pension funds to insurance companies have poured money into private debt strategies seeking higher yields than public bonds offer. Even during the recent market turbulence, private credit fundraising held up relatively well (2023 volumes were only slightly down from records and 2024 is expected to surpass 2023 in fundraising.
This means private lenders are sitting on a lot of “dry powder” – roughly $300 billion in unallocated capital ready to be deployed – and they are eager to put that money to work. In 2024, private credit deal activity was very resilient, bucking the slowdown seen in other financing markets. Direct lending funds continued to finance buyouts, refinancings and growth projects even as syndicated loan and bond issuance slumped.
As we head into 2025, conditions are aligning for an even busier year: many private equity sponsors delayed selling assets over the past two years due to high rates and uncertainty, and they’re now poised to launch a wave of M&A deals.
Our outlook and analysis foresee a surge in dealmaking in 2025, supported by gradually improving macro stability. All of this translates into opportunity for companies seeking capital – if you know where to look.
Bottom line: A macro “perfect storm” of high rates, rising default risks, and bank retrenchment is reshaping corporate finance.
But it’s not all doom and gloom.
Private credit is stepping up as a reliable source of capital, often outcompeting banks on speed and flexibility. Private lenders now regularly provide financing for everything from mid-market working capital needs to multi-billion dollar acquisitions.
In many deal processes, companies run a “dual-track” approach, soliciting offers from banks and from direct lenders, which creates competition and often yields better terms for the borrower.
With interest rates still high, private credit isn’t “cheap” money – but it can be smart, strategic money. In the next section, we’ll explore how businesses can use private credit to their advantage in this environment, turning a financing challenge into a growth catalyst.
Leveraging Private Credit Strategically: Stability, Growth, and Minimal Dilution
In today’s climate, liquidity and stability are paramount. Companies need to ensure they have enough financing to ride out economic bumps, while also investing in growth so they don’t fall behind. Private credit can be a powerful tool to achieve these goals, especially when traditional financing falls short.
Here are some strategies and considerations for making the most of private credit:
Shore up your balance sheet and working capital.
If cash flows are under pressure from higher interest expenses or a dip in earnings, consider private credit solutions to stabilize operations. This might include raising a unitranche loan (a single, blended-rate loan that often replaces what would have been a mix of bank loans and junior debt) to refinance short-term debt coming due.
Private credit lenders are often willing to extend credit in situations banks won’t, such as to companies with temporarily stretched leverage or those in out-of-favor industries. They can tailor amortization schedules or offer covenant-lite structures that give the company more breathing room.
The key is to be proactive: address refinancing needs or liquidity shortfalls before they become acute. By engaging with private lenders early, companies have time to negotiate flexible terms – perhaps an option to capitalize interest for a couple of quarters (PIK toggle), or additional debt reserved for contingencies. Such features can buy time during a rough patch without defaulting.
The trade-off is usually a higher interest rate or granting the lender equity warrants, but that can be worthwhile to avoid a crisis. Many private credit funds specialize in “special situations” financing, providing rescue capital or bridge loans to companies facing a gap. With corporate distress on the rise, tapping these funds can prevent a cash crunch from snowballing into insolvency.
Fuel expansion and acquisitions without diluting equity.
Growth remains the imperative for most businesses – yet raising equity capital now can be extremely expensive (if valuations are down) or dilutive to existing owners. Private credit offers a way to fund growth initiatives while keeping ownership intact.
For example, if you’re eyeing an acquisition or a major capital project, a direct lender could structure a bespoke loan to fund it. This might be a term loan with some initial interest-only period until synergies from the acquisition kick in, or a delayed-draw facility that allows you to borrow in tranches as needed for an expansion project.
Unlike public markets, private lenders can move quickly and privately, which is helpful in competitive M&A situations. They often underwrite based on the story and prospects of the business, not just the credit rating, allowing them to get comfortable with growth plans that don’t yet have a track record.
In 2024 we even saw private credit funds financing larger leveraged buyouts that historically would have relied on syndicated bank loans. This means mid-sized and even large companies have the option to go directly to private credit for big-ticket growth financing. The advantage is not only speed but also certainty – direct lenders often commit to the full loan amount and hold it, whereas a bank might underwrite and then syndicate (with risk that market conditions derail the syndication).
Tailor capital structure to optimize cost of capital.
Private credit is not monolithic; it encompasses a range of instruments from senior secured loans to mezzanine debt and structured equity-like loans. Companies can mix and match financing to achieve an optimal structure.
For instance, a company could raise a first-lien loan from a bank (if available) and then layer in second-lien or mezzanine financing from a private fund to top up the total proceeds – an approach that may yield a lower blended cost than an all-private unitranche. We’re seeing more partnerships between banks and private credit lenders, where they club together on deals, essentially sharing the loan (banks take the lower-risk portion, private funds take the higher-yield piece).
Such partnerships can be win-win: banks preserve client relationships and earn fees without overloading their balance sheet, and private lenders get deal flow they wouldn’t otherwise see. From a company’s perspective, being open to these innovative structures can open financing options that wouldn’t exist if you insisted on a plain vanilla loan.
Additionally, if your business has specific assets (like receivables, inventory, equipment, or real estate), consider asset-based financing (ABF) from private credit sources. Private funds are increasingly financing assets like receivables portfolios, royalties, infrastructure projects, and more. These loans are secured by the assets and can sometimes offer more borrowing capacity or longer tenors than unsecured debt.
Maintain discipline and strong fundamentals.
A word of caution: just because capital is available doesn’t mean it should be taken recklessly. Private credit lenders, while flexible, are not shy about enforcing their rights if things go wrong.
The covenant-lite era has its limits; if a borrower can’t service debt, eventually a restructuring or ownership change will occur. The best defence is robust financial planning and transparency with your lenders. Before taking on new debt, stress-test your projections (e.g. what if rates stay high or a mild recession hits?) Choose lending partners who understand your industry and can be constructive through cycles.
The Klar Capital team work with borrowers with predictable cashflows and resilient business models – as a borrower, you should likewise target lenders who are in it for the long haul and not just chasing yield.
Build in covenants that are manageable and align incentives (for example, an equity upside kicker for the lender can sometimes substitute for an overly punitive cash interest or amortisation schedule). By approaching private credit as a strategic partnership rather than a last resort, companies can secure more patient and supportive capital.
And remember, relationship matters: there’s a growing ecosystem of banks, funds, and even insurance companies collaborating in private credit. A company that manages those relationships well can benefit from repeat financing, better terms over time, and even ancillary support (like getting connected to other portfolio companies or resources via the lender’s network).
Klar Capital Views for H2-2025
#1 - Private Credit Becomes a Go-To Funding Source
We expect 2025 to solidify private credit’s role as a mainstream financing option for businesses of all sizes. No longer just for mid-market leveraged buyouts, direct lenders are now competing in large-cap deals and even investment-grade corporate lending. With banks more constrained, borrowers will increasingly turn to private credit for both routine financings and strategic transactions.
In our view, private credit will effectively fill the void left by banks, providing capital for M&A, growth capex, and refinancings that otherwise might stall. This means companies will have more choices – and potentially more bargaining power – when seeking loans, as private funds and banks compete in parallel processes.
#2 - Default Risks Stay Manageable, But Selection is Key
Despite higher interest costs, we believe corporate defaults in private credit will remain relatively contained in 2025, in the mid-single-digit percentages. Many borrowers have proactively adjusted (through cost cuts, PIK interest arrangements, or amendments) to survive the high-rate period. That said, credit quality divergence will widen – strong companies will manage, while overleveraged ones may finally hit the wall as “amend-and-extend” strategies run out of road. Lenders who chased yield at any cost will face a reckoning if hidden stresses emerge.
Our view is that robust due diligence and covenant protections will pay off in 2025. We favor private credit deals backed by assets or resilient cash flows and stress-tested for scenarios. In short, defaults overall should stay low by historical standards, but we anticipate a spike in distressed workouts for the weakest credits – reinforcing the importance of partnering with experienced lenders and sticking to fundamental credit discipline.
#3 - A Deal Boom Powered by Private Capital
We are bullish on a rebound in transaction activity in 2025. M&A volume is poised to surge as clarity improves on interest rates and geopolitical overhangs, unleashing assets that sponsors held back during 2023-24. This will coincide with record levels of dry powder in private equity (over $2.7 trillion globally) looking for deals, which in turn generates demand for deal financing.
Private credit is ready to pounce – direct lenders have hundreds of billions in capacity earmarked for new deals.
We foresee large deployments of private credit capital into leveraged buyouts and growth financing as activity picks up. Notably, private credit funds will partner more with banks or even edge them out in marquee deals, given their willingness to hold sizable loans.
For companies, this means 2025 could be an opportune time to pursue strategic moves (acquisitions, buyouts, expansions), as financing availability will be strong and competition among lenders could improve terms. Our view is essentially that 2025 will be a “borrower’s market” in private credit, as lenders aggressively seek to deploy funds into the deal wave.
2025–2027 Market Predictions
Klar Prediction #1:
Interest rates will gradually ease but won’t return to ultra-low levels.
We expect major central banks to cut rates modestly over the next 2–3 years as inflation comes under control, but “normalized” rates will likely settle higher than the near-zero era of the 2010s.
In practice, this means by 2026–2027 corporate borrowers might see some relief in financing costs, but should plan for an environment where the cost of debt remains materially above what it was pre-2020. In other words, the era of virtually free money is over; a 5%–6% base rate might be the new 2%–3%. Businesses that adapt – for example, by locking in fixed-rate debt where possible or using hedging – will be better positioned.
Lower rates will, however, improve interest coverage and likely reduce default risk on the margin, creating a more benign backdrop by 2027 (a key reason Moody’s projects declining default risk and strong private credit growth ahead). In sum, plan for moderation, not a full reversal, of interest rates.
Klar Prediction #2:
The private credit market will continue its meteoric growth, further transforming corporate finance.
Global private credit AUM will approach $3 trillion (if not higher), roughly double the level of 2023. This growth will be fueled by the ongoing retreat of banks (who will offload more loan exposure to private markets) and the influx of new investors (including insurance companies and retail capital) seeking yield in private debt. Private credit funds are set to expand into new sectors and geographies, and we’ll likely see innovation like private credit ETFs and securitizations to tap broader funding sources.
By 2027, we anticipate private credit will finance a significantly larger share of corporate credit needs, potentially rivaling the syndicated loan market in size. For companies, this means even more financing options: you might routinely consider direct lenders, insurance investors, or private credit platforms for any debt raise. We also predict more blurring of the lines – expect traditional asset managers and banks to further integrate with private credit (via partnerships or acquisitions), making it a core part of the financial system.
One caveat: as the market roughly doubles, competition among lenders could drive some yield compression and looser terms in the mid-term, which benefits borrowers but demands caution to avoid systemic risks.
Overall, the trajectory is clear: private credit will be an indispensable pillar of corporate financing by 2027, not just an alternative.
FAQ
How should businesses evaluate whether private credit is better than raising equity in today’s environment?
Start by aligning financing with your goals. If your business is generating steady cash flows but your valuation feels low, private credit may allow you to grow without giving up equity. Just make sure you can service the debt—run scenarios, assess your repayment risk, and think long-term. A smart capital stack balances cost, control, and flexibility.
What risks do companies often overlook when structuring private credit deals?
A common mistake is focusing too much on the interest rate and not enough on the fine print—like covenants, amortization schedules, and refinancing timelines. These can create operational stress if not negotiated carefully. Also, failing to plan for future credit tightening can leave you stranded. It pays to build in flexibility and work with seasoned advisors.
How can a mid-sized business make itself more attractive to private credit lenders?
Lenders want confidence. Show them you’ve got reliable cash flows, a clear use of funds, and clean, transparent reporting. Strong unit economics and a solid growth story matter too. The more prepared and investor-ready you are, the better terms you’ll secure—and the faster you’ll close.
Disclaimer
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