Private credit has become one of the most discussed corners of institutional investing — and one of the most misunderstood. Daily headlines about troubled borrowers, struggling business development companies (BDCs), redemption pressure, and concentrated software exposure have created the impression of a market under stress. But beneath the noise, the lower and core middle market direct lending segment that has historically powered investor outcomes is performing well, behaving as designed, and, in our view, is about to deliver one of its most attractive vintages in years.
That was the central message from a recent Principal Asset Management webinar, Cutting through the noise: Focusing on private credit investing beyond the headlines, featuring Tim Warrick, Group Head of Principal Alternative Credit, and Matt Darrah, Head of Underwriting for Middle Market Direct Lending.
For institutional investors, such as pension plans, insurance companies, consultants, and wealth platforms, who are evaluating their private credit exposure today, the discussion offered a clear framework for separating the noise in the asset class from what is working exactly as intended.
The recent turbulence isn’t one story; it’s several converging at once.
Warrick pointed to a cluster of catalysts: the so-called “cockroach” credit episode (which, notably, was not a private credit transaction at all but became a proxy for fears about what might migrate into private credit); challenges among both listed and non-listed BDCs, including an attempted forced merger of a private BDC into a public vehicle trading at a fall and spreads compress; the first meaningful wave of redemption requests: what Warrick called “the first real run on the BDCs”; rising non-accruals at select managers; and growing concern about software-as-a-service (SaaS) exposure underwritten on annual recurring revenue (ARR) rather than cash flow, now facing AI disruption risk.
Layered on top, investment banks that lost meaningful underwriting share to direct lenders over the past decade have a structural incentive to highlight cracks in the asset class. As Warrick put it, “Investment banks that underwrite to sell and earn fees are sensitive to losing market share.” Headlines, in other words, should be read with their authorship in mind.
But Warrick’s most important framing was this: the demise of private credit is greatly exaggerated. What’s actually happening is a long-overdue reckoning between the broad label “private credit” and the very different sub-segments it now encompasses.
The single most important distinction for investors today is the difference between lower and core middle market direct lending — where Principal operates — and upper middle market and large-cap private credit, where most of the headline stress is concentrated.
Principal defines the segments precisely:
- Lower middle market: borrowers with $5–$15 million EBITDA and roughly up to $100 million in revenue.
- Core middle market: $15 to $50 million EBITDA, up to $250 million in revenue, with debt facilities typically up to $200–$250 million.
- Overall middle market: extending up to $100 million EBITDA and roughly $500 million in facility size.
- Upper middle market and large-cap private credit: multi-billion-dollar deals where terms increasingly resemble broadly syndicated loans (BSL).
That last point matters. As deal sizes scaled, the terms moved up-market too. Cov-lite structures, payment-in-kind (PIK) toggles, ARR-based underwriting, and looser EBITDA add-backs migrated from the public markets into the larger end of private credit because, as Darrah explained, at that scale you are no longer competing with other direct lenders — you are competing with the BSL market and its CLO buyer base. “You have to offer cov-lite if you are competing against that broadly syndicated loan market. You might differentiate yourself by offering PIK, PIK toggle components to the structure. And so, all those factors impact credit quality and reduce your ability to effectuate better outcomes in a downside scenario.”
In the lower and core middle market, those compromises don’t apply. Every Principal deal carries true, meaningful financial covenants: Debt-to-EBITDA tests, fixed charge coverage tests, and tighter EBITDA add-back discipline. Leverage runs one to one-and-a-half turns lighter than the upper middle market. These loans are typically held by only one to three lenders, dramatically reducing the risk of liability management transactions that have made headlines and correlation risk during periods of stress.
The distinction also shows up in deal flow. When the second-term Trump administration introduced tariff shifts on so-called “Liberation Day,” large transaction activity slowed considerably. But sponsored and non-sponsored lower and core middle market deal flow stayed steady, a reflection of the more durable nature of that market with more idiosyncratic drivers of transactions.
According to Capital IQ, U.S. M&A deals valued at less than $200 million have exhibited much more stability than the rest of the M&A market. The standard deviation for the change in number of deals completed year-over-year is 17% for deals sub $200 million and 29% for deals above $200 million since 2000. You can also see in Exhibit 1 that the lower middle market remains relatively stable in times of distress, such as in 2001, where large deal volumes were down 42% but smaller deal volumes were only down 15%. Even in the Great Recession, large deal volumes declined 38% in 2008 and 32% in 2009, versus 8% and 11% respectively for smaller deals.
To read more about what investors should be watching and what the headlines are missing in today’s private credit market,
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