Structure, governance discipline keys to portfolio resilience
Key take-aways
- Higher-for-longer rates are reshaping private credit risk, exposing weaker structures earlier as floating-rate debt compresses borrower cash flows and narrows the margin for operational underperformance.
- Structural protections – especially covenants – now dominate credit outcomes, with stronger frameworks enabling early intervention while weaker ones lead to abrupt, binary deterioration, delayed recognition, and higher loss severity. The sharp rise in debt restructurings shows that risk does not only crystallise through hard credit events and capital loss.
- Private credit’s valuation opacity and limited secondary markets amplify downside asymmetry, making refinancing risk, liquidity stress, and restructuring activity more relevant than headline default rates.
- For family offices, governance discipline matters more than yield, as downside risk is driven by structure, recovery dynamics, and manager selectivity rather than macro conditions or spread levels. Diligent asset selection and the right tools to make those decisions – such as Moody’s EDF-X – are therefore critical.
Risk in a higher-for-longer environment
The shift to a higher-for-longer rate environment has altered the transmission of credit risk within private markets. For investors, the impact has been less about the general level of credit quality and more about the recognition of the risks of weaker structures. In a predominantly floating-rate market, higher policy rates feed directly into borrower cash flows, compressing interest coverage and reducing the scope for operational underperformance to be absorbed.1
Recent analysis by the Fed highlights that non-bank credit expansions behave differently from bank-led cycles, particularly once financial conditions tighten.2 Credit growth outside the banking system is more weakly anchored to traditional intervention mechanisms and is therefore more sensitive to refinancing conditions and lender behaviour when stress emerges. In such environments, manager performance dispersion widens as structurally stronger borrowers adapt while weaker structures deteriorate more abruptly.
While default rates in private credit have remained subdued thus far, the combination of higher leverage, opaque valuation practices and delayed price discovery has increased downside asymmetry.3 Risk is no longer evenly distributed, and refinancing risk and loss severity matter more than historical default experience would suggest.4 Distressed restructuring (and related liquidity management strategies, such as PIKing) have surged (Figure 1), and should serve to put private credit investors on notice.
Higher coupons provide income, but they do not compensate for weak entry leverage or fragile cash-flow profiles when refinancing at favourable terms becomes less certain. In the current macro environment, outcomes are increasingly determined by structure rather than by the broader economic growth backdrop.1
Importantly for private credit investors, risk does not only crystallise through formal credit events and capital loss. In a less forgiving environment, pressure is increasingly absorbed through amendments and restructurings that defer cash flows, extend maturities or dilute economics, pushing expected returns further into the future and resulting in realised performance that falls short of initial expectations even where principal is ultimately preserved.
Figure 1
Implications for family offices
Family offices approach private credit from a fundamentally different starting point to institutional allocators, particularly in how downside risk is absorbed. They are not benchmark-constrained, rarely measured on relative performance, and typically more exposed to idiosyncratic deal risk.5 Capital preservation, governance, and control therefore matter at least as much as income generation or diversification.
In a higher-rate environment, this distinction becomes critical. Structures that rely on refinancing optionality, covenant flexibility or sponsor discretion are exposed earlier and more abruptly. For family offices, the consequence is asymmetric. While upside is capped by contractual returns, downside is driven by loss severity and recovery outcomes, not by spread levels. The absence of market pricing reinforces this asymmetry. Valuations tend to adjust slowly, smoothing volatility until stress becomes unavoidable. When deterioration is recognised, it is often late in the credit life cycle, limiting the scope for corrective action. Family offices, which often lack the scale or diversification to absorb such outcomes, can be disproportionately affected by delayed intervention.
Governance therefore becomes the primary risk mitigant. Entry leverage, covenant quality, equity cushions and sponsor incentives matter more than vintage or strategy labels. Manager selection is less about access to deal flow and more about discipline, selectivity and willingness to walk away from marginal structures; avoiding adverse selection can be just as important as sourcing yield.
Structure is key to credit performance
The mechanisms through which private credit protects – or fails to protect – capital are structural. Loan documentation, covenant design and intervention rights determine whether stress is identified early and remedied, or deferred until liquidity pressure narrows options and outcomes become binary. Private credit historically offered far stronger lender protections due to its bilateral nature, where lenders negotiate bespoke, maintenance-heavy covenant packages that allow early detection of financial deterioration.
Approximately 80% of direct lending transactions include maintenance covenants, and the typical middle market deal incorporates two actively tested financial covenants, providing family offices with meaningful intervention rights if performance weakens. These structural features create tangible advantages for long-term, capital-preserving allocators such as family offices: earlier visibility into distress, tighter lender control, and a higher ability to negotiate remedies.
For public credit, covenant quality sits at the centre of this shift. As maintenance covenants have weakened or disappeared, lenders’ ability to intervene early in deteriorating credits has diminished. Intervention is delayed until liquidity pressure becomes acute, at which point options become fewer and outcomes become increasingly binary. Figure 2 shows the difference in the US high-yield default rate when we strip out distressed restructurings. The gap in measured default risk is the largest on record.
In private credit, lender control is exercised contractually rather than through market discipline. Weaker covenants and delayed intervention shift risk from a gradual adjustment process to a more discontinuous one. Stress accumulates silently until liquidity pressure forces action, at which point recovery options are limited and loss severity becomes more sensitive to timing than to initial credit quality.
Absent active secondary markets, valuation practices tend to smooth volatility and delay recognition of deterioration.7 When conditions tighten, adjustment is faster and more abrupt. Market microstructure, rather than macro stress alone, determines how fragility is revealed. When creditor protections are weaker and control rights less effective, credit expansions may be more likely to translate into adverse outcomes once conditions tighten.2 Covenant erosion, aggressive leverage structures and delayed intervention increasingly drive credit loss severity, even in the absence of elevated default rates.1
In a higher-rate environment, weaker underwriting is exposed earlier and with less room for repair for both private and public credit markets. Entry leverage, covenant design, sponsor incentives and refinancing optionality play a more decisive role in determining outcomes than they did in the low-rate period. Credit protections are showing signs of erosion (as Figure 1 showed), and higher rates amplify this dynamic. Floating-rate debt accelerates cash-flow stress precisely when covenant flexibility is least effective. Structures that relied on earnings adjustments, delayed amortisation or refinancing optionality to sustain leverage are exposed more abruptly when funding costs rise. In this setting, headline yield provides limited protection against structural fragility.1
Figure 2
Marginal quality slips as the credit cycle churns on
As demand for capital (from both borrowers and investors) remains high, the volume of issuance is becoming increasingly abundant across strategies, vintages and structures. In this environment, the risk of marginal newly issued debt risk potentially begins to slip, a pattern that repeats in every credit cycle. Weaker credits will tend to gravitate towards the most permissive terms, while stronger credits retain negotiating power, with the result that underwriting standards may vary considerably across originators and managers.
Higher rates have brought this into sharper focus. Structures that came to market relying on refinancing optionality, earnings add-backs or covenant flexibility to sustain leverage are exposed more quickly when funding costs rise. Where intervention mechanisms are weak, deterioration is often recognised late, at which point outcomes become binary and recovery options limited.
For family offices, this creates particular challenges, but also points to at least two management strategies. The first is recognition that private credit offers contractual upside but non-linear downside. Returns are capped, while losses are driven by loss severity, timing and recovery rather than entry yield. In a market where credit quality dispersion is widening, the cost of selecting the wrong structure or manager can be high. In public markets, credit ratings, liquid prices, and other methods exist to parse the quality of a prospective investment. In private markets, the tools are more limited, but they do exist. Implied ratings from Moody’s EDF-X, for example, can provide an objective, standardized view of credit risk where none would otherwise exist.
Second, proactive portfolio monitoring becomes critical. Although investment exit mechanisms for private credit are much more limited, overall portfolio loss mitigation is more effective when you can identify what proportion of your portfolio is under stress, and which exposures in particular are weakening. The failure of First Brands is a good example. The company’s rapid collapse caught many investors flat-footed as the true risk of default was not reflected in the loan price (Figure 3). Despite the fact that financial information for First Brands was not publicly available, Moody’s EDF-X probability of default (PD) measure based on trade credit data captured the escalating risk. Credit investing is always a game of avoiding losers rather than picking winners, but this is especially true for private credit.
Figure 3
Conclusion
The higher‑for‑longer rate environment has shifted the credit landscape from a focus on general credit quality to a greater emphasis on structure, governance and early warning. In a market dominated by floating‑rate loans, higher funding costs accelerate cash‑flow stress and reduce the time available for credit repair. As a result, structurally weaker deals – those with thin covenants, high entry leverage, or reliance on refinancing optionality – are deteriorating faster and with greater severity, even as headline default rates remain subdued. Valuation opacity and limited market liquidity further mask emerging problems, causing losses to crystallize late in the credit life cycle when corrective action is most difficult.
For family offices, these dynamics magnify the importance of prudent governance. The path to successful outcomes depends less on the macro backdrop and more on disciplined underwriting, strong investor protections, robust sponsor alignment, and rigorous monitoring. In this environment, tools that improve transparency – such as Moody’s standardized, model‑based risk measures or early‑warning indicators – can provide meaningful advantages, especially where financial reporting is limited.
References
1Moody’s Ratings (2025) Private Credit – Global: Private credit innovations are transforming risks in novel ways, November 17. Available to subscribers
2Federal Reserve Bank of New York (2024) The disparate outcomes of bank- and nonbank-financed private credit expansions. New York: Federal Reserve Bank of New York, Liberty Street Economics. Available at: https://libertystreeteconomics.newyorkfed.org/2024/08/the-disparate-outcomes-of-bank-and-nonbank-financed-private-credit-expansions/
3Bank for International Settlements (2025) Retail investors in private credit. BIS Bulletin No. 106. Basel: Bank for International Settlements. Available at: https://www.bis.org/publ/bisbull106.htm
4Moody’s Ratings (2025) Global Asset Management Outlook 2026, December 9. Available to subscribers
5UBS (2025) Global Family Office Report. Zurich: UBS Global Wealth Management. Available at: https://www.ubs.com/global/en/family-office/reports.html
6Federal Reserve Bank of New York (2021) Covenant-Lite Loans and the Weakening of Creditor Protections. Liberty Street Economics. Available at: https://libertystreeteconomics.newyorkfed.org/2021/01/covenant-lite-loans-and-the-weakening-of-creditor-protections/
7Moody’s Ratings (2025) Global Structured Finance Outlook 2026, December 16, Available to subscribers
Contacts
Hanna Sundqvist
Head of Private Credit, Europe
Asset Management
+44 203 314 2217
Hanna.Sundqvist@moodys.com
David Hamilton
Head of Asset Management Research
+1 212-553-5931
David.Hamilton@moodys.com
About
This article is a product of Moody’s Asset Management Research team, part of Moody’s Analytics (“Moody’s”), a division of Moody’s Corp. separate from Moody’s Ratings. The analysis and viewpoints expressed herein are solely those of Moody’s Asset Management Research team.