Private Credit Report 2020 — The Test That Wasn't

March 2020 delivered private credit the event it had never experienced. Economic activity contracted abruptly, borrowers in affected sectors faced immediate revenue collapse, and the default cycle that would test the asset class's central claims appeared to have arrived.

Managers responded as the playbook required: drawing down revolvers, assessing portfolios sector by sector, engaging with borrowers early, and preparing for workouts. First-quarter marks fell.

Then the test was cancelled.

The policy response — described at the macro level in the 2020 slot-A report — was extraordinary in speed and scale. Rates went to near zero, liquidity facilities were established, and direct fiscal support flowed to businesses and households. Credit markets that had frozen in March were functioning by May. Borrowers who had faced a liquidity crisis found refinancing available.

Defaults rose, but far less than the economic contraction implied. By the second half of 2020, private credit portfolios had substantially stabilised, marks had recovered, and the asset class had come through what looked like a severe stress test in good condition.

The interpretation placed on this is where the analysis matters. The performance was real. What it demonstrated is narrower than what it was taken to demonstrate.

It demonstrated that private credit performs well when policymakers prevent a default cycle. It did not demonstrate that private credit underwriting is superior, that concentrated positions work out better, or that direct lenders manage distress more effectively than syndicated markets — because those propositions require actual distress to test, and the distress was removed.

What the 2020 record actually measures

This distinction is the substance of the report, and it generalises well beyond this asset class.

A performance record measures outcomes under the conditions that occurred. It supports inference about future performance only under similar conditions.

The conditions in 2020 were specific and unusual:

• An external shock, not a credit cycle originating in over-lending.
• An extraordinary and rapid policy response, larger and faster than any precedent.
• Direct fiscal support to borrowers, which improved credit quality by means entirely outside the lender's control or underwriting.
• A brief duration. The acute phase lasted weeks, not the quarters or years a typical credit cycle runs.

Under those conditions, a portfolio of leveraged loans performed well. That is a genuine and useful data point about how the asset class behaves in a policy-supported shock.

It is not a data point about how it behaves in a conventional default cycle: a slow accumulation of deterioration driven by over-leverage and weak underwriting, unfolding over years, without policy intervention because none is warranted.

A test that is interrupted does not produce a result. It produces a record of the interruption.

The distinction matters because of what followed. The 2020 record was cited extensively in subsequent fundraising as evidence of the asset class's resilience. Capital flowed in on that basis, and the asset class grew substantially between 2020 and 2024 — on a track record that had not been generated in the conditions the record was being used to speak to.

This is not a criticism of the managers. The performance was real and they reported it accurately. It is an observation about inference: the same numbers support a much narrower conclusion than the one commonly drawn from them.

Payment-in-kind expands

The most consequential technical development of 2020 concerned how stress was accommodated rather than resolved.

A payment-in-kind (PIK) arrangement allows a borrower to add interest to the principal balance rather than paying it in cash. Instead of paying $10m of interest, the borrower's debt increases by $10m.

PIK has legitimate uses. A fundamentally sound business facing a temporary liquidity problem can preserve cash while the problem resolves, and the lender is compensated by a higher balance. In a genuine external shock, this is exactly the right instrument.

But it has a specific and important effect on what is observable:

• The loan remains current. The borrower is meeting its obligations as amended, so it does not appear in default or non-accrual statistics.
• Reported income continues. The lender accrues the PIK interest as income, so the fund's yield appears unaffected — even though no cash has been received.
• The balance grows. The borrower owes more, so if the underlying problem does not resolve, the eventual loss is larger.

The consequence for anyone reading credit statistics is direct. A portfolio with rising PIK income and stable default rates may be experiencing more stress than a portfolio with lower PIK income and slightly higher defaults. The first has accommodated the stress; the second has recognised it. Default rates alone cannot distinguish them.

There is a further wrinkle on the income side. PIK income is non-cash but is reported as income, which flows through to reported yield and, in fund structures, can flow through to fees calculated on income. A rising PIK share therefore raises reported returns while reducing cash generation — two things moving in opposite directions under one headline number.

PIK income share is disclosed in BDC filings. For a listed BDC, the proportion of investment income that is PIK rather than cash is publicly available quarterly. It is one of the more informative and less watched indicators in the asset class, and it costs nothing to obtain.

Marks: appropriate, and misleading

Private credit valuations fell in the first quarter of 2020 and recovered substantially by the third.

That pattern was appropriate. Valuation should reflect the expected recoverable value of the loan. In March, expected recoveries genuinely looked worse. By September, following the policy response, they genuinely looked better. Marking down and then back up reflected reality.

But the pattern reinforced an impression that does not follow from it: that private credit marks are responsive and that the asset class's reported volatility reflects its true volatility.

The reasons for caution are the ones the 2016 report sets out, and 2020 illustrated them rather than resolving them:

• The markdown was smaller than in traded credit. Comparable traded loans fell further before recovering. Whether that reflects better assets or smoother valuation is not determinable from the data.
• The recovery coincided with the policy response, so the marks are consistent with both a responsive valuation process and a slow one that happened to be moving when conditions improved.
• A single episode cannot distinguish them. Determining whether private marks respond appropriately requires observing a period when conditions deteriorate and stay deteriorated — which 2020 did not provide.

2020 is consistent with private credit valuations being accurate and with them being smoothed. It does not discriminate between the two, and it is frequently cited as though it did.

Growth on an unearned record

Private credit grew substantially in the years following 2020, and the 2020 experience was a significant part of the argument for it.

The reasoning presented to allocators ran roughly: the asset class faced a severe economic shock, performed well, and therefore demonstrated resilience that justified a larger allocation.

Each step is defensible in isolation. The chain does not hold, for the reason set out above: the shock was severe but the credit cycle was prevented.

Several factors compounded the growth beyond what the record alone would have supported:

• Yield scarcity intensified. With rates near zero after March 2020, the institutional yield problem described in the 2016 global report became acute. Private credit offered yield when almost nothing else did.
• The regulatory origin argument remained sound. Banks had not returned to leveraged lending; the structural case was intact and independent of the 2020 record.
• Capacity appeared abundant. Private-equity-owned companies continued to need debt, and deal activity surged in 2021, generating loan demand.

The result was rapid growth in an asset class whose central claims remained untested — into a period, from 2022 onward, when rates rose sharply and the borrowers' interest burden rose with them, since most direct loans are floating rate.

That is the setup the 2022 and 2024 reports describe.

What a conventional default cycle would look like

The argument that 2020 was not a test rests on a claim about what a real test consists of. It is worth specifying, because the specification is what makes the claim falsifiable rather than merely sceptical.

A conventional credit cycle differs from 2020 on five dimensions:

Origin. A credit cycle originates in the lending itself — accumulated over-leverage, deteriorating underwriting standards during a competitive period, borrowers financed on optimistic assumptions. 2020 originated externally, in an event no lender's underwriting could have anticipated. A lender is not being tested on their judgement when the shock was unforecastable.

Duration. A credit cycle unfolds over years. Deterioration accumulates, borrowers deplete their resources gradually, and defaults arrive in a wave rather than a moment. 2020's acute phase lasted weeks.

Policy response. A conventional cycle receives no extraordinary intervention, because none is warranted — the deterioration is a normal consequence of the preceding expansion. 2020 received the largest and fastest policy response on record.

Correlation. In a conventional cycle, defaults cluster because they share a common cause: the credit conditions that produced the lending. In 2020 the clustering was sectoral and driven by an external event, which is a different correlation structure.

Recovery conditions. In a conventional cycle, workouts occur in a weak economy with few buyers and depressed asset values. In 2020, by the time most workouts would have occurred, asset values had recovered and financing was available.

Each difference matters for what the record demonstrates. A portfolio that performed well through a brief, externally-caused, heavily-supported episode has demonstrated resilience to that. It has not demonstrated that its underwriting was better, that its concentration improves workouts, or that its marks reflect realisable value — because none of those was tested.

The three claims the asset class makes can only be evaluated against defaults that arise from the lending, accumulate over years, and are worked out without support. That is the test. It has been deferred repeatedly and it has not happened.

What an allocator could act on

Ask what conditions a performance record was generated under. A record covering a period of low defaults, one brief supported shock, and a rate rise whose effects were being deferred is a record about those conditions. Inference from it to a conventional cycle requires an argument, and the argument is rarely made explicit.

Watch PIK income share. It is disclosed quarterly in BDC filings, free on SEC EDGAR, and it leads default statistics because PIK conversion precedes non-accrual which precedes default. It also captures the specific thing default rates cannot: stress being accommodated rather than recognised.

Distinguish contractual PIK from amended PIK. Contractual PIK was priced at origination. PIK converted from cash after the fact is a distress signal. Filings generally distinguish them and the distinction is the informative part.

Note that PIK income raises reported yield while reducing cash generation. A fund's reported income can rise while no cash is received, and in some structures fees are calculated on that income. The gap between reported income and cash received is itself a signal worth tracking.

Compare private marks to a traded loan index over the same quarters. The 2020 mark pattern is consistent with valuations being accurate and with them being smoothed; a single episode cannot distinguish them. But the comparison against the S&P/LSTA index over multiple periods is informative, and both series are available.

Do not read growth as validation. The asset class grew substantially after 2020 on a record cited as evidence of resilience. The structural case — regulatory bank retrenchment — is genuinely strong and entirely independent of the 2020 record. Conflating the two attributes to performance what is actually a rule change, and the rule change says nothing about whether the loans are priced correctly.

What 2020 established for private credit

• The stress test began and was cancelled, leaving the asset class's central claims exactly as unverified as before.
• The record generated measures the policy response, and supports a much narrower inference than it was used for.
• PIK expanded, establishing an instrument that accommodates stress without recognising it — and a disclosure line worth watching.
• Mark behaviour was consistent with two opposite interpretations, and the episode could not distinguish them.
• The asset class grew on that record, into conditions that would test it far more seriously.