9% yields are compensation, not generosity. Understand the tradeoff before chasing income.
KEY TAKEAWAYS
Credit markets are beginning to show subtle stress signals through restructurings and fraud allegations. These events are not systemic yet, but they are reminders of how credit cycles quietly evolve.
Private credit expanded after the Global Financial Crisis due to regulatory constraints on banks. The ecosystem now includes BDCs, direct lenders, banks providing leverage, and retail investors chasing yield.
In the Tricolor and MFS cases, lenders alleged fraud and over-pledged collateral. That shifts the narrative from simple default risk to due diligence failure.
Banks are not absent from this space–they finance the financiers. Exposure is layered and interconnected throughout the system.
Higher yields of 8 to 10% represent compensation for credit, liquidity, and underwriting risk. That risk is embedded in the structure and must be acknowledged.
MY HOT TAKES
The market’s fixation on AI is distracting investors from more foundational risks building beneath the surface. Credit markets, not chips, may prove more consequential.
Oversupply of capital often leads to underwriting complacency late in cycles. Competition for deals can subtly erode discipline.
Fraud allegations are temperature changes in the room, not isolated technicalities. They force a reassessment of risk controls.
Retail investors are often indirectly exposed to private credit through banks, BDCs, and income vehicles. The responsibility to understand that exposure ultimately flows downward.
Yield is never free. The spread over Treasuries is the price of uncertainty, leverage, and imperfect information.
You can quote me: “Credit cycles rarely announce themselves with sirens. They whisper first.”
Where credit is due. Are you scratching your head over how some of your most healthy stocks continue to be in the red? Stocks that have solid balance sheets, great growth prospects, iron-clad fundamentals, and top-notch management continue to be punished by the market. You are not alone in your confusion–all of Wall Street is right there alongside you. Now, I don’t mean to just write off this recent phenomenon as the cost of doing business, but it actually IS. I am not going to pen another blogpost/newsletter about all this, because my regular followers already know the game plan for these mostly-tech-oriented companies. I bring this up this morning, because I want you to stop fixating on the wrong hotspot. I know that it is fun to debate AI, robots, agentic blah-blah-blah, chips, nuclear energy, and… Jenson’s leatherwear, but sometimes you have to focus on some boring stuff to avoid what could be far more impactful on the value of your investments.
The smoke that is appearing around the debt/credit markets is easy to overlook.
You may even claim that it’s not your problem because you don’t own any of those stocks, referring to companies like Blue Owl who was recently in the news for cutting its dividend and gating its redemptions. Chances are, however, that you do own a few top-shelf banks that do have exposure to those very companies and through them, ultimately, lenders that you may not want to associate with.
Your exposure to those companies goes beyond your most pristine bank stocks, because the entire economy is girded by debt markets; if those weaken…there will be nowhere to hide.
Several months back I was honored to be invited to an intimate discussion hosted by Axios which included some very influential voices and operators on Wall Street. The discussions quickly switched to “what are your biggest concerns.” I was not shy about my concern over the credit markets. While some of the participants politely agreed, others pressed back vehemently. It turns out that those who disagreed were incidentally private credit lenders. They were confident–as they should be–in their loan books. Their loan books. But they were missing the point.
You could have the cleanest apartment in the building, but if the rest of the building is infested with cockroaches, they will eventually show up.
Let’s turn back the clock. In 2025, the slow-motion restructurings at Tricolor and First Brands finally ran out of runway. Tricolor Auto Group, which had been negotiating with lenders after earlier payment stress, moved from workout mode into formal proceedings and filed for Chapter 7 liquidation in September 2025, effectively shutting down operations and beginning the process of asset disposition. Around the same time, First Brands Group, an auto-parts manufacturer, filed for Chapter 11 bankruptcy protection in late September 2025 after months of balance-sheet strain and liquidity pressure. What had started as missed payments and amendment talks the year prior ultimately became court-supervised processes in Q3, putting both companies into formal bankruptcy. The incidental convergence of those two bankruptcies got just enough press to catch the eye of the broader market, which spurred some folks to pay closer attention to private credit exposure.
My concern about the credit markets, however, began prior to those very public bankruptcies. My concern was that there was too much hot money chasing too few good investment opportunities. Prior to the Fed’s tightening regime which lasted from 2022 to 2024, there were ample opportunities in the real estate sector for secure lenders to finance projects with rapidly expanding valuations. Most of those completely disappeared as valuations dropped with rising interest rates and borrowers hunkered down. Now, this is not about those investments, it’s about the folks who make a living by lending. Banks make money by lending! If demand for loans goes down, guess what, so does bank revenues. But we all know that there is always someone who needs to borrow money. In fact, there are plenty of companies who need to borrow money, but the problem is, those companies are far riskier bets. To understand it better, we need to understand some history.
After the Global Financial Crisis (GFC), the pendulum didn’t just swing, it slammed. Regulators tightened capital rules, stress testing became a religion, and balance sheets at the big banks were scrubbed cleaner than a surgical ward. Leveraged lending, middle-market direct loans, anything remotely “hairy” from a credit standpoint–those assets suddenly became expensive to hold under Basel capital requirements. So the banks initially stepped back. Not because they forgot how to lend. Not because the returns disappeared. But because the regulatory math no longer worked. And into that vacuum stepped the Business Development Companies and private credit funds like Apollo, Ares, Prospect Capital, Owl Rock (Blue Owl), and KKR. They weren’t bound by the same capital ratios. They could move faster, price risk higher, and promise yield to investors starving in a zero-rate world that followed the GFC. The opportunity wasn’t born out of genius. It was born out of constraint.
But Wall Street hates vacuums. Over time, the banks found their way back–just differently. Instead of holding the risk outright, they financed the financiers. Firms like JPMorgan Chase, Bank of America, and Goldman Sachs provided warehouse lines, subscription facilities, securitizations, leverage against loan portfolios. They underwrote and distributed. They advised on restructurings when the tide went out. In other words, they didn’t abandon lower-quality credit–they repositioned around it. Fee income replaced balance sheet concentration. Exposure became indirect, layered, structured. So, while the BDCs became the visible face of middle-market risk in the post-GFC era, the major banks were never truly gone. They just changed seats at the table.
And those BDCs didn't stop by raising capital from big banks, they also borrowed from retail investors, as many learned with last week's news from Blue Owl Capital. Through publicly traded vehicles like Blue Owl Capital Corporation and other non-traded BDC structures, private credit exposure filtered straight into brokerage accounts, retirement portfolios, and income-focused ETFs. Investors chasing 8%, 9%, 10% yields weren’t buying abstract institutional paper–they were effectively lending to middle-market borrowers through layered structures that feel bond-like but behave very differently under stress. Add in interval funds, private REIT-like wrappers, and exchange-listed BDCs such as Ares Capital Corporation or Prospect Capital Corporation, and suddenly this isn’t just a story about private partnerships in conference rooms. It’s a story about everyday investors participating–often unknowingly–in the same credit cycle that institutions built.
I hope that by now you can see just how complex the credit markets are. More importantly, even though you own a top-shelf Bank like JPMorgan Chase, you too may have some exposure, albeit quite limited to these more complex, and possibly riskier credit. Now, it’s important to step back and say that there is no evidence that a default tsunami is about to hit due to a large-scale macro event. Further, it is also important to recognize that there is nothing wrong with these Business Development Companies. But it is important to recognize that when you invest in a BDC or traditional bank for that matter, you are relying on them to perform the necessary due diligence required to underwrite that lending.
Unfortunately, history has shown us that due diligence tends to get sloppy late in credit cycles as lenders compete over slim pickings. And that brings us back to 2025. In the Tricolor case, lenders didn’t just suffer losses–they alleged fraud. Court filings and creditor statements claimed that collateral values were misstated and that representations made to lenders did not reflect the true condition of the receivables. When that kind of allegation enters the record, it changes the temperature. A default is one thing. A fraud allegation is another. It suggests that somewhere between underwriting and monitoring, something was missed–or worse.
Then came last night’s news around Market Financial Solutions, another direct lender backed by private credit capital. There too, fraud has been alleged. The borrower is accused of over-pledging collateral, effectively promising the same assets to multiple lenders. Among the investors reportedly impacted are funds tied to Ares, Apollo, and other large private credit participants. When collateral is over-pledged, it means the recovery math that underpinned the underwriting model may not be what lenders thought it was. And here is the uncomfortable truth: it is not the borrower’s job to catch that. It is the lender’s.
That is the business. You get paid 8%, 9%, 10% because you are supposed to do the work. You are supposed to inspect the books. You are supposed to verify the collateral. You are supposed to ensure that the same inventory, receivable, or asset is not being quietly used as security somewhere else. When hot capital floods into a space, competition intensifies. Terms loosen, covenants get lighter, and monitoring becomes more… er, optimistic. And sometimes optimism drifts into sloppiness.
This is not an indictment of the entire private credit universe. It is a reminder of how cycles work. When capital is scarce, lenders are disciplined. When capital is abundant, discipline can erode at the margins. The oversupply of money chasing yield does not automatically create fraud, but it can create conditions where red flags are harder to see because nobody wants to slow the deal down. Nobody wants to lose allocation. Nobody wants to tell investors that cash is sitting idle earning nothing.
And this is where the responsibility ladder becomes clear. The first burden sits with the direct lender–the private credit fund or BDC underwriting the loan. That is their mandate! They are paid to assess credit risk, verify collateral, and structure protections. The second burden sits with the banks that finance those lenders. If a bank is providing warehouse lines, subscription facilities, or leverage against a portfolio, it too has a responsibility to understand the underlying exposures. And finally, the burden flows all the way down to the retail investor–you and me– who allocate capital to these vehicles in search of yield.
None of this means these are bad investments. It means they are credit investments. There is a difference. When you see a 9% yield in a world where Treasuries yield less, that spread is not a gift. It is compensation. Compensation for liquidity risk. Compensation for leverage. Compensation for underwriting risk. Compensation for the possibility that something in the stack does not behave as modeled. That risk is not theoretical. It is embedded in the coupon.
Sorry to hit you with basic finance, but this is BASIC FINANCE.
The question is not whether private credit is broken. The question is whether we collectively understand what we are being paid for. When allegations of fraud surface, whether in Tricolor or in the MFS situation, it forces us to revisit that basic principle. Due diligence is not a marketing line. It is the foundation of the asset class. If collateral was over-pledged, if representations were inaccurate, if monitoring failed, then the system did not function as tightly as investors assumed.
Again, there is no evidence that a credit apocalypse is around the corner. The economy is not collapsing. Loan books across many platforms remain sound. But credit cycles rarely announce themselves with sirens. They whisper first. They show up as isolated restructurings. Then a few fraud allegations. Then tighter lending standards. Then repricing–a polite way of saying your stock sells off.
The burden is shared. Private credit managers must underwrite properly. Banks financing them must know what sits beneath the surface. And retail investors must understand that yield is earned, not granted. There is a cost to that 8%, 9%, 10%. The cost is credit risk. It is there. Acknowledge it. Stay focused. And please, do your homework.
YESTERDAY’S MARKETS
Stocks had a mixed close yesterday closing off session lows, dragged down by tech. NVIDIA’s strong earnings were not enough to convince skittish investors that the AI capex growth can be sustained. Surprised–but not so much. 😉 Treasury yields declined and the benchmark 10-year closed at 4%, which is an important technical floor, driven down by ongoing geopolitical tension and the AI fear trade.
NEXT UP
Producer Price Index / PPI (January) is expected to have materially slowed to 2.6% from 3.0%. PPI is considered a leading indicator of consumer inflation. If retailers are paying more, there is a good chance that you will be paying more.
MNI Chicago Business Barometer PMI (Feb) may have slipped to 52.1 from 54.0.
Next week we still have plenty of important earnings announcements along with PMIs, more regional Fed reports, Retail Sales, and monthly employment figures. Check back in on Monday for weekly calendars and your chance to be the smartest person in the room.