Private credit is facing a confidence test. The sharp decline in public software valuations in early 2026 raised concerns that AI could weaken established software companies, with those fears quickly spreading to private credit given software’s significant share of the direct lending market. Investors began questioning the quality and carrying value of software loans, as well as borrowers’ ability to refinance or repay their debt.
Meanwhile, several large private credit funds faced elevated redemption requests from investors seeking to withdraw capital, and some limited the amount investors could take out in accordance with their fund terms. This reinforced concerns that problems in one market segment could signal broader trouble, although exposure differs considerably across managers and portfolios.
These concerns deserve attention, but several separate issues are being treated as one.
Some software borrowers might be facing challenges, and certain private credit funds are feeling the strain of investor withdrawal requests. However, this does not imply that private credit portfolios are generally distressed or misvalued. A thorough valuation process allows managers and investors to accurately identify where the real risks are located.
Three Related but Distinct Issues
The current discussion involves three principal risks: borrower credit risk, valuation risk and fund-level liquidity risk.
- Credit risk reflects the potential for loss resulting from a borrower’s failure to satisfy its contractual financial obligations. In the current market, this risk is concentrated largely among SaaS companies and related software businesses, where AI could reduce demand, compress margins, increase customer attrition or weaken future earnings. The impact will vary: some borrowers face significant disruption, while others may benefit from AI or have more defensible business models.
- Valuation risk is whether a loan’s value aligns with market demands, as a loan can become riskier and lose value even if the borrower is current on payments and in compliance with covenants. Public selloffs don’t necessarily hammer private loan values equally.
- Liquidity risk emerges when investors want to withdraw from assets that can’t be quickly sold, especially in private loans, which are less liquid and may have redemption limits, leading to restrictions when requests exceed those limits.
These risks, and redemption restrictions in particular, may be unpopular with investors, but they do not necessarily mean the underlying loans have stopped performing. In many cases, redemption limits prevent a fund from being forced to sell assets at unfavorable prices or to sell more liquid investments to meet withdrawal requests. A fund can face redemption pressure while its borrowers continue to make payments, just as a borrower’s credit quality can deteriorate even when the fund has sufficient liquidity.
Valuation provides the bridge between these issues. It measures how changes in a borrower’s prospects and the broader market affect the value of the underlying loans. It also gives managers a defensible basis for calculating net asset value, communicating with investors, and managing liquidity.
A Performing Loan May Still Decline in Value
A loan can remain current and still be worth less than par – a lesson reinforced during the 2008 credit crisis, when the value of many loans and securities fell before borrowers stopped making payments. Consider a software company valued at $100 when a lender provides $40 of debt, equal to 5.0 times EBITDA and a 40% LTV. If the company’s value falls 35% to $65 while its debt remains unchanged, its LTV rises to approximately 62%, leaving the lender with a much smaller cushion against further losses.
That change alone would not automatically move the loan’s internal credit rating from BB+ to BB-. If the decline reflects weaker earnings prospects, greater competitive pressure or reduced cash flow coverage, however, it could support a multi-notch downgrade following a broader review of the borrower.
That change should prompt the lender to revisit the loan’s shadow credit rating, or its internal assessment of the borrower’s creditworthiness. A multiple-notch downgrade would generally produce a higher required market yield. When the market requires a higher return than the loan’s existing contractual yield provides, the loan’s fair value may fall below par.
The result does not have to be an extreme markdown. The valuation should account for the severity and duration of the risk, the borrower’s performance and ability to adapt, the lender’s position in the capital structure, available collateral, and expected recovery in a downside scenario.
This is why the analysis must go deeper than whether payments are current. Valuation is forward-looking. Waiting for a missed payment or covenant breach may mean waiting too long to recognize a change that market participants already consider relevant.
When Stable Marks Should Draw Scrutiny
It is relatively easy for limited partners to compare a fund’s marks from one reporting period to the next. Determining whether those marks should have moved requires more work. If a portfolio has meaningful exposure to software businesses facing credible AI disruption, yet its marks and credit ratings remain unchanged, investors should ask questions.
Managers should show they’ve reconsidered the original underwriting thesis, updated forecasts, evaluated market yield changes, and tested downside scenarios. A stable mark might still be supportable if the borrower operates in a defensible niche, retains customers, has strong cash flow, or unique products. Structural protections or low leverage can also mitigate credit risk. The key is that conclusions come from updated analysis, not initial assumptions.
The same principle applies in the other direction. A broad software selloff doesn’t mean managers should cut unrelated credits arbitrarily. Loans to car washes, landscaping, or service businesses likely remain unaffected as software multiples decline. These borrowers have their own risks, and a sector specific selloff’s impact on them may be limited.
A credible valuation process should produce dispersion, with marks accurately reflecting risks of individual borrowers and sectors. If assets don’t change during market stress, investors may doubt its responsiveness. If all assets move together, they may question its specificity.
What a Defensible Valuation Process Requires
In periods of rapid change, private credit managers should be able to show that their valuation process addresses several core questions:
- Has the original underwriting thesis changed?
- Do forecasts reflect current information?
- Has the borrower’s risk profile changed?
- Do valuation assumptions reflect current market conditions, particularly with respect to yields?
- Is the conclusion documented?
This work also helps managers demonstrate the quality of their underwriting and ongoing portfolio management. Strong underwriting does not end when a loan closes. It includes continually assessing whether the borrower is performing according to the original thesis and whether emerging risks change the lender’s expected return or recovery.
Valuation Cannot Eliminate Liquidity Risk
Even a well-valued portfolio can face a liquidity mismatch. Private loans may take months or years to mature, refinance, or sell, while some funds permit regular redemptions. Redemption limits manage this mismatch by protecting remaining investors from selling assets at low prices or borrowing heavily for withdrawals.
Several funds that limited redemptions in 2026 were applying preset quarterly caps rather than declaring that their portfolios were distressed. As Oaktree observed in an April 2026 market commentary, those limits had largely operated as designed by helping funds avoid fire-sale liquidations.
Using a contractual limit doesn’t end the analysis. Investors want to know why redemption requests increased, how the fund plans to generate liquidity, and if withdrawals are concentrated among a few investors. They should also see if the fund is selling its most liquid assets to meet requests, potentially changing the risk profile for remaining investors.
Accurate valuation doesn’t create liquidity, but it does prevent misleading performance indications, offering investors clearer portfolio insights.
The Market Needs More Precision
Private credit shouldn’t be seen as a single exposure. A fund focused on software loans faces different risks than one invested in service, industrial, and consumer businesses. A semi-liquid vehicle for individual investors has different redemption dynamics than a closed-end fund (or for that matter, an ETF). A borrower with fundamental deterioration shouldn’t be evaluated the same way as one remaining sound amid market volatility.
The environment doesn’t prove private credit valuations are wrong, but it makes defending unsupported stability harder. Managers with software exposure should be ready to explain how they have reassessed enterprise values, future earnings, LTV ratios, credit ratings, and yields. Those with unaffected portfolios should explain why their marks are still appropriate.
Investors do not expect every valuation to decline. They need evidence that each valuation has been tested. That discipline is what separates a sector-specific credit problem from an economy-wide concern and a valuation issue from a liquidity issue.
