The business of private credit: What happens when a private credit deal runs into trouble?

The financial professional take on “The Lead” newsletter series is dedicated to help financial professionals stay informed about developments, and movements in private capital investing.

Bottom-line upfront

1. Private credit's structural advantage in defensive sectors offers clients a meaningful source of income generation and portfolio resilience that does not depend on favorable economic conditions.
2. Middle market loans in service-oriented industries, including heating, ventilation and air conditioning (HVAC), commercial landscaping, and wastewater management, carry historically lower default rates than cyclical peers, making them a disciplined foundation for wealth preservation conversations.
3. Experienced manager selection is the critical variable: lenders with proven contingency frameworks, rigorous underwriting of customer durability, and strong sponsor relationships are positioned to navigate the credit events that inevitably occur in any portfolio.

When clients ask how private credit holds up when conditions deteriorate, the answer lies in how experienced managers structure deals long before trouble arrives.

Building all-weather portfolios in private credit

Experienced private credit managers build all-weather playbooks designed to navigate any business cycle or headline risk. This discipline is critical for maintaining a successful track record of low defaults and losses, because middle market loans do not trade the way broadly syndicated loans or high-yield bonds do. Even with resilient companies in defensive industries, once you book it, you own it.

So, what happens when one of these ground-level deals runs into trouble? Less-cyclical sectors give you more time to react, but things still happen. And as we will discuss in later episodes, private equity ownership provides helpful oversight and professional management, but the higher leverage in buyout financings leaves less room for mistakes.

Why service-oriented middle market businesses anchor defensive allocations

HVAC, fire and security systems, commercial landscapers, and wastewater management are good examples of "old economy" core middle market businesses. They are essential, must-have services with recurring revenues, sticky customers, and strong free cash flows. They also tend to be less driven by consumer sentiment. The skilled performers are sustained by having an intense focus on customer service, creating moats around their client and vendor relationships.

Yet these are still small- to medium-sized enterprises, many of which are experiencing institutional ownership for the first time. Trouble comes in various guises, both internally and from many outside factors. Management overbuilds or overextends their merger and acquisition (M&A) programs. Poor cash controls can create unexpected working capital shortfalls. A large customer unexpectedly walks. A key vendor misses a delivery. A top salesperson goes to a competitor. A storm wipes out a major facility.

How experienced lenders structure around risk before it arrives

Experienced lenders and their sponsor partners expect problems like these and create contingency plans. In businesses where cash goes out before it comes back in, structuring around the working capital cycle is essential. Underwriting customer durability focuses not just on concentration risk, but on what keeps the customer from going to a competitor.

In regulated industries, supplier qualification processes create real switching costs that protect incumbency. When a business serves multiple end markets, those segments are less likely to stumble at the same time. Sponsors reinforce this work by bringing industry expertise through operating partners who coordinate with management teams on corporate development and strategy.

What the defaults show

This discipline shows up in the numbers. According the Cliffwater Direct Lending Index (years-end 2023-2025), defaults for service-oriented middle market companies run below those of cyclical peers and the business development company (BDC) average. As with all historical performance data, past results reflect the discipline applied during that specific period and under those market conditions. Advisors should note that private credit investments carry credit risk, default risk, and liquidity constraints that require careful suitability evaluation for each client.

Allocating toward defensive, service-oriented businesses is not a retreat from return potential. It is a disciplined strategy built around what happens when things go wrong, because sometimes they do. Every portfolio has to weather storms. The skilled managers do not just hope for sunshine; they have already packed the umbrella.