Wall Street may be panicking over private credit, but insiders don’t understand what it is.

So who is right?

Investors have been so worried recently about the stability of private credit that their frenzied selling has sent the VIX “fear” index up 35% over the past month. They are spooked by the September collapse of Tricolor Holdings, a subprime auto lender and dealership, revealing allegations of fraud in which the company promised the same guarantee to multiple banks. Private credit suffered another blow late last month when First Brands, an auto parts supplier, collapsed into bankruptcy with $10 billion, triggering federal investigations into $2.3 billion in missing funds. Then, on October 16, regional banks Zions Bancorporation and Western Alliance revealed fraud-related losses, catalyzing a market rout that wiped $100 billion in market capitalization from U.S. bank stocks and pushed market volatility to a four-month high.

Large institutions took stock of their damage: JPMorgan suffered $170 million in losses for Tricolor, UBS disclosed more than $500 million in exposure to First Brands, Jefferies revealed $715 million in bad debts. The private credit market – which grew from $200 billion to $3,000 billion globally in fifteen years – suddenly appeared vulnerable.

But credit analysts and executives who spoke with Fortune have mixed views on the Wall Street panic. Many argue that failures are not private credit problems at all. These examples, they say, are traditional bank lending booms, and this mislabeling reveals more about competitive tensions between old-guard banks and private credit disruptors than true systemic risk. The question, however, is whether these analysts are right or whether they are dangerously underplaying the cracks in a $3 trillion market that is systemically important to global finance.

The problem of definition

“First Brands, if we had rated it, would not have been considered a private credit transaction in any way,” said Bill Cox, chief rating officer of the Kroll Bond Rating Agency, which tracks thousands of private credit loans. “Its main debt was fully syndicated government loans. »

This distinction is important. The broadly syndicated loan (BSL) market, dominated by large commercial banks, operates differently from the direct lending market that defines private credit. BSL loans are issued by banks, syndicated to multiple investors and traded on public markets with daily pricing. Private credit loans, on the other hand, are two-way transactions between a lender and a borrower, held until maturity in a “buy and hold” strategy, without trading in the secondary market.

The First Brands bankruptcy primarily involved BSL debt and receivable “factoring,” a form of lending in which banks buy a company’s accounts receivable at a discount in hopes of profiting later when customers pay their invoices in full. None of these activities represent the core direct lending business that companies like Ares, Apollo and Blackstone have built.

“None of them do factoring,” Cox said of the dozens of private lending platforms that offer firm pricing. “We reviewed all of our CLOs, BDCs and other facilities to determine exposure to First Brands. Exposure was de minimishe said, referring to collateralized loan bonds (loan packages sold to other investors) and business development companies (which are created as investment bets on distressed or struggling businesses).

Brian Garfield, who heads U.S. portfolio valuation at investment bank Lincoln International, which conducts more than 6,500 quarterly valuations of private companies, echoed this view: “First Brands [largely had BSL facilities and] this is not the direct lending market. I think it’s important that we understand that that in itself is really important, because there’s this whole combination of things that everyone puts everything in one basket,” he said. Fortune.

The real state of private credit

This is not to say that private credit faces no challenges. Proprietary data from Lincoln International tracking the direct lending market shows that defaults – technical violations of loan terms rather than defaults – have increased from 2.2% in 2024 to 3.5% currently. The use of payment in kind (PIK), where distressed borrowers defer paying interest in cash, has increased from 6.5% of transactions in the fourth quarter of 2021 to 11% today, with “bad PIKs” (repriced mid-transaction) increasing from 33% to more than 50% of this total.

“Are there any cracks? Yes,” Garfield agreed. “But on average, are we seeing strong fundamental EBITDA growth? Yes.” Its data shows year-over-year EBITDA growth over the trailing twelve months of 6-7%, the highest level since the first quarter of 2021.

KBRA’s analysis of 2,400 mid-market companies with about $1 trillion in debt tells a similar story. Cox’s team projects that defaults could peak at 5%, which he admitted is “much higher than what this sector has experienced,” but he said it was “relatively” low for public market comparables, the measure by which private company valuations can be derived by comparing companies to other similar companies that are already publicly traded.

Why this panic?

Given that the fundamentals are not dire, analysts point to several factors other than credit quality to explain investor anxiety, including guardrails and less strict documentation processes.

“If something grows like a weed, maybe it’s a weed,” Timur Braziler, who covers Wells Fargo’s regional banks, told Fortune. “The availability of credit over the last five years, when multiple sources are competing for the same loan, perhaps underwriting is not as tight.”

Andrew Milgram, managing partner and chief investment officer of Marblegate Asset Management, an alternative investment firm focused on middle-market distressed and special-situation investments, offered a more pointed critique: The competitive dynamics of unregulated lending inevitably lead to a deterioration in standards. “When banks made loans, they were subject to supervision,” he explained. “As these loans moved out of the banking system and into an unregulated environment, they began to compete for business by relaxing underwriting documents and standards. »

Private loans are typically made by non-bank lenders such as alternative asset managers, private equity firms and pension funds.

Without the safeguards and protections provided by traditional banks, which are beholden to regulators and the federal government, disaster can ensue, according to Milgram, who has long been skeptical of the private credit market.

“Lending has been regulated in societies forever. In fact, Hammurabi’s code envisaged regulating lenders because every society, everywhere and at all times, has recognized that sustainable and responsible lending is essential for the proper functioning of the economy,” he added.

Cox sees a different dynamic at work: competitive tensions between traditional banks and new entrants into private credit have led, he says, to a misinterpretation of the overall risk of private credit and direct lending. “If your neighbor tells you it’s your dog pooping on the lawn and you know it’s not your dog, that’s pretty frustrating,” he says, noting that Tricolor and First Brands were primarily bank loan failures, not private credit problems.

He admits, however, that there are segments of the private credit market that are more exposed and involved in “riskier parts of credit” where lenders make high-risk loans in the hope of high returns.

Private credit has a reputation for being aimed at small, middle-market businesses that are highly leveraged and potentially unable to obtain traditional bank financing. Although these companies may offer higher returns to compensate for risk, they are more vulnerable to financial shocks.

What comes next

The debate on the risks of private credit will not end with these bankruptcies. The Brazilian expects more cases of fraud to appear: “Just because of the abundance of credit, it is logical that you have more of these bad characters. » However, he does not see any systemic risk for the banking sector.

Tim Hynes, global head of credit research at Debtwire, expects continued stress but not catastrophe: “Weaker companies are starting to be hit by tariffs and the economic slowdown. You will see an increase in bankruptcies, but there is no systemic risk.”

The real test might be transparency. Unlike BSL loans which are priced daily in the market, private loan valuations are less transparent and are updated quarterly using subjective methodologies. “It’s really opaque,” ​​notes Braziler. “It’s really difficult to fully understand who the ultimate borrower is.”

As BlackRock doubles down with its $12 billion HPS acquisition and Dimon warns of the cockroaches, the private credit industry faces a credibility test. The question is not whether some loans will default – they will. It’s about whether the industry’s risk management, documentation standards and valuation practices can pass a financial stress test.

“Anyone with significant exposure to corporate credit markets, and particularly corporate credit markets with leveraged loans, should re-examine their portfolio in extreme detail at this time and think seriously about the quality of underwriting that went into making these loans and the veracity of the reporting that supports their understanding of company performance,” Milgram said.

For now, analysts who follow private credit more closely see warning signs, not an apocalypse. But in a market where definitional confusion obscures risk and competitive tensions fuel narratives, separating the signal from the noise is increasingly critical and difficult.