When we published our annual outlook in January, the defining feature of leveraged credit markets, from where Axar invests, was a paradox: headline indices sitting at cycle tights while, beneath the surface, the supply of distressed paper kept expanding. As we move into the back half of the year, that paradox persists and has intensified. We have come to describe a growing distressed opportunity set alongside overall tight credit spreads
as the Velvet Rope Market. On the inside, it is quite the party: capital is abundant, dare we say exuberant. The financing required (and available) to build out artificial intelligence and data center infrastructure appears, for now, effectively limitless. New issuance across high-yield and broadly syndicated loan markets has picked up, even if the activity is dominated by mundane opportunistic repricings and term-outs. In short, technicals remain firmly in borrowers’ favor, and that gravitational pull continues to coax issuers off the bench.
But on the other side of the velvet rope, those thatcan’t get in are starting to get anxious as the temperature drops and the street becomes barren. These issuers are, disproportionately, the leftovers of the post-COVID issuance surge: companies financed in a rate regime that no longer exists, built on growth assumptions that never panned out, now unable to clear the bar for entry. This is where Axar’s investment pipeline is concentrated, and the cohort continues to grow weekly.
With that backdrop, what follows are three insights about where we believe risk, and opportunity, are concentrated in the back half of 2026.
“Adult swim” was the lifeguard’s call to clear the children from the pool to make room for the grownups. That is roughly where this market now sits: tough portfolio management decisions arriving alongside increased market dispersion, making conditions suitable for experienced practitioners only. Against that backdrop, it is worth noting what is highly unlikely to happen: there is no Federal Reserve riding to the rescue for the “have-nots.” While crude is well off its 1H 2026 highs, rates have settled at levels meaningfully higher than the ones at which this debt was underwritten, and the Fed’s balance sheet continues to be in runoff mode, slowly siphoning liquidity from the market. This rate recalibration higher has had an outsized impact on middle market issuers, as indicated by interest rate burden delta over the past five years on the Russell 2000 composite vs. the S&P (Chart 1).
Therefore, at this point, while we do not forecast rates, we ascribe a very low probability to a scenario that would save many of these balance sheets. Absent that rescue, what remains is a grind, unfolding in four phases:
Phase 1 was the precondition: the long accumulation of debt from the post-GFC era through 2022, when capital was cheap and plentiful, and rising enterprise values supported the case for rising debt loads (Chart 2).
Phase 2 was the collision of that debt with a higher rate world starting in 2022, and the Sponsor response to it: a record wave of liability management exercises across credit markets in 2024 and 2025 (Chart 3a). The kicking of the can, if you will. Research suggests that over 90% of LMEs end up restructuring (in-courtand out-of-court) again within three years (Chart 3b).
Phase 3 is where we sit today, with the supply of debt trading sub-$80, absent a brief COVID surge, at an all-time high (Chart 4a). Market anxiety is migrating away from LMEs and toward something more painful: hard defaults. New pockets of strain keep appearing: the software selloff, private credit redemptions, the growing supply of distressed paper, and estimates for lower recoveries in default situations. The list of troubled sectors, across consumer, housing, software, and industrials, is lengthening.
Furthermore, while the LME wave of 2024 and 2025 significantly smoothed over default-induced volatility, it also stacked an enormous amount of lower-rated maturities into 2028 (Chart 4b).
Phase 4, which we expect to define the next couple of years, will be marked by the lagging arrival of rating agency downgrades and a rise in defaults.
This is a grind, not a crash, and likely a longer, slower one than its predecessors. This environment aligns directly with Axar’s methodical approach to due diligence and research. We focus on identifying opportunities supported by durable market dynamics, where underlying conditions are expected to persist for the foreseeable future.
Every vintage carries the character of the conditions that made it. The 2020 to 2022 vintage of private
equity and private credit deals was laid down amid a confluence of multiple permissive conditions: near-zero rates, abundant liquidity, and growing enterprise value multiples that supported everything around them. It is, in other words, the anti-Bordeaux: a vintage that shows worse with every year it ages.
This is where stress is disproportionately concentrated across credit markets. The deals struck in that
window, especially those done on businesses that have since failed to grow into their capital structures, are showing strain well in excess of the broader market: default rates across 2020–2022 vintage bonds and loans run meaningfully above other vintages (Chart 5). This is a useful lens for understanding mid-year dispersion: not necessarily market-wide deterioration, but a vintage problem.
Unsurprisingly, the COVID cohort is also showing historically weak DPI for private equity investors five years later (Chart 6).
Relatedly, we think the 2020–2022 vintage marked the last phase of credit purely as a beta product. In the post-GFC era, with policy rates pinned to the floor and central bank balance sheets backstopping asset prices, very little across secondary markets got cheap enough for long enough for credit investors to generate excess returns. Faced with a world in which it had become genuinely difficult to mine for alpha, credit managers decided they needed to scale. These credit funds pivoted to prioritize scaled origination to compete with banks, and the pitch to LPs evolved accordingly: away from “we have better ideas and better analysts” toward “we can originate deals others cannot.” In a market starved of secondary dislocation, that was a legitimate marketable edge. It also meant that an enormous amount of capital was deployed by an apparatus optimized for volume rather than credit selection, which is precisely what culminated in the massive growth of the 2020–2022 vintage deals.
The irony is that this market is reorienting investors to prior logic: investing, not allocating. Dispersion is back and opportunities to create alpha have arrived, allowing for a stock picker’s (or credit picker’s) market once again.
We expect actionable stressed and distressed situations in this vintage to continue to build. We intend to participate as we always have: through rigorous underwriting, early exposure, and a growing commitment as temporary fixes give way to more durable outcomes.
In private credit, you can check out any time you like, but you can never leave. Redemption requests have become the defining feature of private credit in the first half of 2026. They are not, in our reading, evidence that private credit does not work. They are evidence of something more fundamental: an awareness, on the part of the investors who supplied the capital to the direct lending investment community, of uneven underwriting, incomplete risk management, and incentives that were never quite aligned with their own.
Executives at many of the largest managers have been quick to characterize the trouble in private credit direct lending as a small and unrepresentative corner of an otherwise healthy market. Perhaps that’s the case, but it’s self-serving, and it brings to mind Charlie Munger’s line: “Show me the incentive, and I’ll show you the outcome.”
The fee architecture and business model of direct lenders addressed a legitimate concern: it pulled
credit risk out of the banking system and diffused it, first across institutional balance sheets and then, increasingly, into the wealth channel. But the whole apparatus rested on two key factors: asset managers performing adequate due diligence, and end investors who didn’t have to mark-to-market. Managers could clip an origination fee on the way in and a management fee for the duration, including on leverage, while limited partners enjoyed institutional-quality leverage and a slight spread bump versus public markets, the combination of which flattered gross returns. Furthermore, it was increasingly scalable. When a market is growing like this and the structure is working, all parties tend to keep pushing.
In retrospect, the fees earned through capital deployment across private equity and private credit during the 2020–2022 vintage largely reflected the market environment, prevailing incentive structures,
and the broader momentum of the cycle. The structure reinforced an environment in which the marginal deal always looked acceptable, because the reward for deploying was immediate and concrete while the penalty for poor origination was distant and diffuse.
So as asset managers push LPs toward the vast, multitrillion-dollar opportunity in private credit’s next chapter, we tend to focus on one key realization in real time: today’s private credit stress is tomorrow’s capital solution. It remains very early. But the sheer scale of the stress is drawing in real resources, with banks and asset managers building the machinery to intermediate single names, portfolio trades, continuation vehicles, and secondaries. The opportunity set this creates is, we believe, in its
opening innings.
We are positioned to be a provider of liquidity and a buyer of complexity, through discounted secondary purchases of private credit and directly originated capital solutions.
Death, taxes, and intensifying market noise: three of life’s certainties. While increased noise invariably makes the business of credit picking more challenging, it is also exactly what allows assets to get cheaper than they otherwise would. For a patient investor like Axar, with the right capital and the right team, noise is not the enemy; it can create the conditions for the next great investment. This market is allowing us to actively engage across our key sourcing channels: our core distressed loan-to-own franchise, opportunistic stressed credit investments held to maturity, and directly originated capital solutions, all for businesses that cannot get past the velvet rope on their own. This is a longer, slower cycle than the ones before it, a grind, not a crash. That suits us. It rewards the patient, the prepared, and those built to act when the moment comes.
This material is provided for informational purposes only and does not constitute an offer to sell or a solicitation of an offer to buy any securities or investment advisory services. The views expressed herein are those of Axar Capital Management LP (“Axar”) as of the date of publication and are subject to change without notice.
This material is not intended to provide, and should not be relied upon for, investment, legal, or tax advice. Any forward-looking statements or discussions of potential outcomes are based on current expectations and assumptions and are subject to change. There can be no assurance that any investment strategy will be successful or that any outcomes discussed herein will be achieved. References to specific investments are provided for illustrative purposes only and do not represent all investments made by Axar. Past performance is not indicative of future results. All investments involve risk, including the possible loss of principal.
(i) Bloomberg, Apollo
(ii) FRED, Pitchbook
(iii) JP Morgan Research
(iv) Harvard Law School Research
(v) JP Morgan Research
(vi) Pitchbook
(vii) Bloomberg
(viii) Hamilton Lane
Axar Capital Management LP
402 W 13th Street, 5th Floor New York, NY 10014
Email: investorrelations@axarcapital.com
Axar Capital Management LP is a $3.3 billion opportunistic investment manager focused on U.S. middle market companies with $200 million to $800 million in debt outstanding. Founded in 2015 and 100% employee-owned, Axar specializes in complex situations where traditional institutional capital operates inefficiently. The firm is headquartered at 402 W 13th Street, New York, NY.