*** HAPPY NEW YEAR ***
2026 is my 18th year blogging.
Today should be a rest day but yesterday I came across two items I deem important to share.
This is from the excellent Chris Whalen (The Institutional Risk Analyst):
What about the train wreck in private equity and credit? The backlog of unsold companies in private equity is monumental. As the FT notes: “Private equity firms sell assets to themselves at record rate.” This will not end well. And the end may begin in 2026 as private equity companies fail in growing numbers.
Last year we saw concerns about the private credit and private equity markets begin to surge, but the best is yet to come. Credit is slowly rolling over in the US markets, one reason why equity markets around the world are likely to outperform the US in 2026. Under-utilized banks have fed the two-headed mania in private credit and private equity caused by quantitative easing in 2020-2023 with loans to non-depository financial institutions (NDFIs). (…)
Source: FDIC/WGA LLC
The strong rally in silver and gold, and the weakness of crypto tokens, are leading the decline in US fortunes when it comes to the equity markets. Literally dozens of crypto ventures have failed in the past year, notes Comsure. Crypto exchange collapses have led to $30–50 billion in investor losses, the UK consultancy reports. But the greater concern is the mounting backlog of corporate insolvencies, a real and growing danger that could push the US into recession even as short-term interest rates fall.
According to statistics released by the Administrative Office of the U.S. Courts, annual bankruptcy filings totaled 542,529 in the year ending June 2025, compared with 486,613 cases in the previous year. Business filings rose 4.5 percent, from 22,060 to 23,043 in the year ending June 30, 2025. Non-business bankruptcy filings rose 11.8 percent to 519,486, compared with 464,553 in the previous year.
The growing number of individual and corporate insolvencies are part of a rebound of a long-term trend of falling defaults. For more than a decade, total bankruptcy filings fell steadily, from a high of nearly 1.6 million in September 2010 to a low of 380,634 in June 2022. Total filings have increased each quarter since then, but like loan default rates, they remain far lower than historical highs.
Like credit metrics, the statistical measures of default reflect a growing tendency for negotiation rather than formal events of default. Some estimates suggest that 1 out of three insolvencies are restructured out of court. As the chart below illustrates, cash accrued but not collected is over $100 billion, but banks are avoiding taking possession of foreclosed real estate (REO).
Source: FDIC
One way to measure the stress building in private equity and credit is the poor performance of lenders to private businesses. Long-term equity returns for business development companies (BDCs) have been hammered since the middle of 2025 and now are running at a negative 4% vs up 16% appreciation for the S&P 500, KBW reports. The chart below shows the VanEck BDC (BIZD) ETF vs the S&P 500.
Source: Google Finance
“Short sellers are taking note of rising signs of stress within the private credit market, and using publicly traded BDCs to signal that outlook,” notes our colleague Nom de Plumber from his perch high in the world of large bank risk. Banks have substantial exposures to private equity, but most of the risk is borne by private lenders lower in the credit stack. Or at least that is what many bankers believe.
PIK or “Payment-in-Kind” refers to a mystical financial arrangement where interest or dividends are paid with additional securities, goods, or services instead of cash, allowing companies to conserve cash flow but increasing debt principal. PIK is commonly seen in high-risk sectors like leveraged buyouts and venture debt, with examples including PIK Notes and PIK Interest. But there are literally thousands of private equity financed companies now using PIK to avoid default.
Income from payment-in-kind debt, which allows borrowers to defer interest and can signal an inability to pay with cash, has been rising across BDCs, reaching 7.9% in the third quarter, according to data from Raymond James. In the third quarter, 3.6% of investments across BDCs were on non-accrual status, a designation that indicates a lender expects losses, Raymond James data show.
Like REITs, BDCs are pass through vehicles that must pay out most income. “BDCs still accrue the PIK loan coupons as non-cash income, but lack the corresponding cash to pay the required dividends, to maintain their favored IRS treatment,” NDP notes further. “If they lose that tax treatment, there is risk that such PIK loan coupons become taxable at the BDC level, rather than treated as simply passed through to BDC shareholders for taxation. Then, the BDCs would lack the cash to pay the IRS, too.”
The growing number of illiquid private equity-backed companies presents a huge problem for Wall Street sponsors and lenders. “Even with interest rates falling and the number of initial public offerings increasing in recent months, it has not made a dent in the industry’s backlog of at least 31,000 companies valued at $3.7 trillion, according to research from Bain & Company,” Maureen Farrell reported in The New York Times. She continues:
“That amount exceeds last year’s record of 29,000 companies valued at $3.6 trillion. Many recent attempts by private equity firms to sell companies or take them public have stalled…. The private equity firm Thoma Bravo has failed repeatedly over the past several years to sell two companies it owns for an acceptable price. Thoma Bravo bought J.D. Power, the consumer analytics company, and ConnectWise, a software company, in 2019 and hasn’t found a buyer for either. This year, in light of the tough market, the private equity firm did not attempt another sale, according to two people briefed on the matter.”
Consider an appropriately named example. United Site Services, a provider of portable toilets owned by private equity firm Platinum Equity, filed for bankruptcy with plans to wipe out $2.4 billion in debt and hand the company to senior lenders, Steven Church, Reshmi Basu, and Harry Suhartono of Bloomberg report. They write:
“The bankruptcy case comes less than 18 months after the company reshuffled its debt stack in order to raise cash. Platinum, which acquired United Site in 2017, would likely see its investment wiped out, since shareholders cannot collect anything in bankruptcy unless creditors are paid in full. The company owes secured lenders more than $2.7 billion, court filings show.”
We expect to see a growing number of BDCs, private equity sponsors and other parties forced to recognize asset impairments and related losses in the New Year. The backlog of private equity companies using PIK or other means to avoid bankruptcy is going to be cleared out substantially as it becomes clear that merely lowering short term interest rates will not make moribund PE companies attractive to investors.
The damage done to the PE sector is massive and could see more than half of all managers unable to raise new funds. These Lame Duck managers will eventually exit the sector once the remaining proceeds of asset sales have been returned to investors.
Weakness in the US equity markets in 2026 could contribute to a negative environment for credit that has been years in the making. Moreover, we expect that the steady decline in bank default rates viewed over the past year, an accounting illusion manufactured by bankers, investment sponsors and regulators acting together, will end when it becomes apparent that the Fed is not coming to the rescue of the private equity and credit community.
If we assume that visible default rates on bank loans and private debt are understated by the same monetary excesses and forbearance that caused bankruptcies to fall for a decade, the period ahead is very likely going to involve a painful and extended reversion to the mean in terms of credit expenses.
The charts below shows delinquency and loss-given default on $13 trillion in mostly prime bank loans as of the end of Q3 2026. As any bank CEO or chief financial officer will tell you, credit loss rates have been very low for a very long time.
Source: FDIC/WGA LLC
Although the Fed’s QE program inflated home prices 50% it also took net loan loss rates for banks down to ~ 50% of par in 2021, this compared to ~ 95% after 2008. QE enabled some very stupid and foolish behavior by investors and lenders. These behaviors are only partly described by the nominal level of interest rates because, of course, we must account for leverage in calculating the full scope of the prospectives losses.
Lend More Upon Default (LMUD) has concealed the scope of the disaster and even pushed down reported loan default rates, but we suspect that 2026 earnings results will see the benign trend in bank credit defaults come to an end.
KKR is one of the savviest credit lender around. The theme in its latest analysis is “Move up in quality, particularly in Credit”.
We see Credit losses continuing to normalize in 2026, especially around 2021 vintages and sub-scale businesses. (…)
As we look ahead investors should brace for higher loss rates. Indeed, recent events across both Private and Public Credit markets have been a useful reminder of what happens when investors drift away from basic credit discipline and/or over-concentrate to one sector or time period.
Weak underwriting, limited transparency in due diligence, and overly permissive covenants all tend to show up the same way: deteriorating fundamentals and then higher loss rates, especially in parts of the economy experiencing rolling recessions rather than broad-based stress. (…)
The mix and quality of risk now matter more than the quantity of risk one takes. In our view, 2026 should be a year to upgrade portfolios rather than stretch for yield, including moving up in quality where we can, locking in fixed-rate income where it is still adequately compensated, and leaning into collateral-backed structures that offer both contractual cash flows and protection in downside scenarios.
This is the essence of our High Grading thesis. Rather than reaching down in rating or structure to pick up a few xtra basis points of spread, we think investors will be better served by reallocating towards high-quality High Yield over Loans, favoring CLO liabilities and Asset-Based Finance where structural protections and diversified collateral pools help mitigate loss severity, and selectively deploying Capital Solutions/Structured Equity where the supply/demand imbalance is most acute.
We also favor international diversification, including leaning into Asia, at this point in the cycle.
Done thoughtfully, this approach should allow investors to preserve yield carry, improve capital efficiency (especially for insurance balance sheets), and build portfolios that are better positioned to navigate an environment of episodic volatility, idiosyncratic losses, and ongoing macro uncertainty.
This right when the US government is taking several regulatory and executive actions to “democratize” access to private equity and private credit for retail and retirement investors.
Among many measures, the SEC is exploring changes to the “accredited investor” definition to focus more on investor sophistication rather than strictly wealth or income criteria.
How will the SEC objectively measure sophistication?
Sophistication is not intelligence, and certainly not judgement (remember LTCM).
Wealth and income are much better measures of one’s ability to weather investment losses than sophistication. This is what the “accredited investor” definition was for.
***
Winston Churchill: The Second World War (VI), August 28, 1944:
It has been said that the price of freedom is eternal vigilance. The question arises, What is freedom?
There are one or two quite simple, practical tests by which it can be known in the modern world in peace conditions, namely:
Other quotes:
“Whoever would overthrow the liberty of a nation must begin by subduing the freeness of speech.” ―Silence Dogood, likely pseudonym of Benjamin Franklin.
“Each of you, for himself or herself, by himself or herself, and on his or her own responsibility, must speak. It is a solemn and weighty responsibility and not lightly to be flung aside at the bullying of pulpit, press, government or politician.” (Mark Twain)
“It is by the goodness of God that in our country we have those three unspeakably precious things: freedom of speech, freedom of conscience, and the prudence never to practice either of them”. (Mark Twain)