In private credit, banks are ‘quietly preparing for some distress on the horizon’ by requiring ever-stricter legal terms for debt-ridden companies

Private credit lenders are significantly tightening deal terms, with data from Noetica indicating a sharp increase in protective clauses such as "J.Crew blockers," now present in 45% of deals (up from 15% in early 2023), and "anti-Petsmart" language, found in 28% of contracts (up from 4% in 2023). This trend, alongside higher lien subordination protection and declining leverage ratios, suggests lenders are proactively preparing for potential distress in credit markets, despite current default rates not being unusually high. While some borrower flexibility on spending has increased, the overall shift reflects a more cautious lending environment and a perceived heightened risk outlook by sophisticated market participants, further evidenced by rising covenant defaults and payment-in-kind deals.

Analysis

Private credit deals are exhibiting a notable tightening of terms, with "J.Crew blocker" clauses now present in 45% of Q3 2025 deals, a significant increase from 15% at the start of 2023. Similarly, "anti-Petsmart" language has surged to 28% of contracts in Q3 2025 from just 4% in 2023. This trend is further evidenced by an increase in lien subordination protection to 84% from 42% last year and declining leverage ratios.

These structural protections indicate lenders are proactively preparing for potential future distress in credit markets, as articulated by Noetica CEO Dan Wertman, despite current default rates not being unusually high. Supporting this cautious outlook, covenant defaults have risen from 2.2% in 2024 to 3.5% currently, and payment-in-kind (PIK) deals have increased from 6.5% in Q4 2021 to 11% today. Kroll Bond Rating Agency projects defaults could peak at 5%.

While terms are tightening structurally, lenders have simultaneously granted borrowers more flexibility in spending, including investments and dividends, and more generous EBITDA calculation methods. This dual approach suggests a sophisticated market adjustment, reflecting lenders' anxiety about future credit market conditions and a strategic re-evaluation of risk. The overall market sentiment is strongly negative with a cautious tone.

Key Decisions for Investors

• Investors should scrutinize private credit deal terms for increasing structural protections like J.Crew blockers and anti-Petsmart language, as these signal heightened lender caution regarding future market distress.
• Monitor rising covenant defaults and payment-in-kind (PIK) deal volumes as leading indicators of potential credit quality deterioration, aligning with Kroll's projected 5% default peak.
• Evaluate portfolio exposure to companies with high leverage or those reliant on flexible spending terms, recognizing that while flexibility exists, the underlying shift is towards greater lender protection.