When the Environment Changes, the Math Changes with It

Beginning in early 2022, central banks began raising rates with a speed and magnitude that markets had not anticipated. For private credit borrowers carrying floating rate obligations, the impact was immediate and arithmetic.

A loan originated in 2021 at a spread of 500 basis points over a near-zero benchmark rate carried an annual interest burden of approximately 6%. That same loan, with rates elevated, carries a burden approaching 9.3%. The increase in debt service cost represents a rise of more than 50% in annual interest expense. For borrowers whose income projections were built on assumptions of stable or declining rates, this shift was not a modest headwind. It was a structural recalibration of the economics underlying the transaction.

The projections that supported those loans were, in many cases, entirely reasonable at the time of origination. Consumer purchasing power was strong. Government stimulus had injected significant liquidity into the economy. Demand for goods, services, and space was elevated. The income and cash flow assumptions embedded in those loan structures were not fabricated. They reflected conditions that were real.

Those conditions are no longer the prevailing reality. Economic activity has moderated. Stimulus has receded. Consumers are managing elevated costs with purchasing power that has not kept pace. And the assets against which significant private credit was extended are facing a valuation environment that has returned, with some difficulty, to something resembling fundamental reality.

The Hidden Risks with Sophisticated Borrowers

Here is where the 2026 landscape diverges in an important way from prior credit cycles that ended badly.

In previous cycles of credit excess, the borrowers who eventually defaulted were often individuals or institutions that had not fully understood the obligations they were assuming. The mathematics of their situation had not been modeled carefully. Their defaults, when they came, were frequently the result of genuine financial distress.

The borrowers carrying a significant portion of today’s private credit are not in that category. They are institutional. They are sophisticated. In many cases, they understand the mechanics of their loan structures with a precision that rivals or exceeds the lenders who originated them.

For a borrower who overleveraged an asset against projected income that has not materialized, the calculus of continuing to service that debt is not a question of financial hardship. It is a question of economic rationality. When the asset’s current value falls below the outstanding loan balance, when the income the asset generates no longer covers debt service at prevailing rates, and when the equity originally invested in the transaction has been fully eroded, the cost-benefit analysis of default changes entirely.

Bankruptcy proceedings, for a sophisticated institutional borrower with limited recourse, are not a catastrophe. They are a mechanism that have been taken into account. An orderly restructuring or liquidation resolves an uneconomic obligation, clears the balance sheet, and in some cases positions the same party to reacquire the same asset, or a comparable one, at the distressed price that their own default helped to create.

“Many borrowers who refinanced during the early 20′ cashed out and had no skin left in the game.”

The dynamic played out in documented detail across the New York real estate market. A large residential portfolio, financed with over a billion dollars in floating rate debt, became unserviceable as interest expenses rose more than 75% in two years. The income the portfolio generated, constrained by regulatory limits on rental increases, could not support the debt at prevailing rates. The bankruptcy filing that followed was not a surprise.

A portfolio valued at $826 million on the balance sheet, carrying over $1.1 billion in debt, sold at auction for $451 million. The lender recovered cents on the dollar. The borrower walked away from an uneconomic structure that the changed interest rate environment had made impossible to sustain. The full loss across all creditors was closer to $650 million.

What This Means for Private Credit as an Asset Class

None of this suggests that private credit is without merit as part of a well-constructed portfolio. The asset class serves genuine economic functions. It provides capital to borrowers that traditional markets cannot efficiently serve. It offers structural protections, floating rate income, and return premiums that remain compelling relative to public fixed income alternatives, even in a more challenging environment.

What it suggests is that not all private credit is equivalent, and that the due diligence required to distinguish between well-underwritten, appropriately structured lending and the vintage of transactions originated during a period of exceptional conditions and exceptional optimism is neither simple nor trivial.

The questions worth asking before allocating to private credit in the current environment are not the same questions that were sufficient in 2021. The collateral supporting these loans, the income projections embedded in them, the recourse available to lenders in the event of default, the concentration of the portfolio by sector and vintage, and the alignment of interests between the general partner originating the loans and the investors providing the capital are all variables that demand scrutiny.

Private credit has matured rapidly as an asset class. The sophistication of investors entering it has not always kept pace with the sophistication of the borrowers within it.

At Guzhuna, we examine asset classes like private credit not to endorse or dismiss them, but to understand every aspect of the risk to determine whether they belong in a specific client’s portfolio, and if so, in what form, at what allocation, and alongside what other considerations.

The most consequential decisions in wealth management are rarely the ones made in the enthusiasm of a trend. They are the ones made with clarity about what the trend actually contains.