Deteriorating asset quality, falling collateral values and a growing rush to exit have roiled private credit markets, prompting comparisons to the global financial crisis.
But the surge in loan defaults, while painful, could shake off the stress from the $3 trillion sector and usher in what one industry expert called a “healthy reset” after the first major liquidity test.
ares management On Tuesday, just a day after it chose to limit investor withdrawals from its $10.7 billion private credit fund. Apollo Global Management announced similar measures for one of its vehicles. Ares has set the redemption cap for its Ares Strategic Income Fund at 5% after withdrawal requests soared to 11.6%, Bloomberg reported.
including other managers. blue owl capital Cliffwater and Cliffwater have also scrambled to halt or limit withdrawals in recent weeks as investors retreat from the sector amid rising default concerns.
Comparisons with the situation in the run-up to the 2008 global financial crisis are now becoming even stronger, as concerns grow over the quality of the underlying loans.
Morgan Stanley recently warned that private credit direct lending default rates could rise to 8%, well above the historical average of 2% to 2.5%, with pressure concentrated on sectors vulnerable to AI disruption, such as software.
“Significant but not systemic.”
But Morgan Stanley analysts led by strategist Joyce Jiang also said the 8% jump in defaults was “significant but not universal,” pointing to lower leverage among private credit funds and business development companies compared with 2008.
Ares Management.
So what would a default spike of that size actually look like?
Sunaina Sinha Haldea, global head of private capital advisory at Raymond James, said: “An 8% default rate moves private credit from a ‘zero-loss’ fantasy to a more normal credit asset class. Partly painful, but ultimately a healthy reset, freeing up capital to stronger companies.”
He said normalizing from extremely low defaults would be “painful for some funds” but “healthy for the asset class if it forces better underwriting and more realistic valuations”.
William Barrett, managing partner at Reach Capital, said an 8% or 9% default rate would manifest primarily through so-called “shadow defaults” such as maturity extensions and covenant waivers. Lenders use these “fix and pretend” tools to keep borrowers afloat and avoid immediate bankruptcy.
While payment-in-kind contracts can delay the return of cash, increase debt, and signal increased stress on the system, they can also serve as an effective “release valve” to stabilize companies and prevent them from failing completely, he added.
Apollo Global Management.
“For the real economy, this means capital will be caught up in restructuring, potentially making future lending conditions even more stringent,” Barrett told CNBC in an email.
pressure points
Concerns about credit quality have spread to private markets following the high-profile failures of First Brands and Tricolor within the U.S. auto parts sector last year. Although these failures related to asset-based finance and bank syndicated debt rather than traditional middle-market direct lending, they spotlighted the broader issue of risky debt in private markets.
Since then, attention has shifted to software exposure in direct lending (estimated at about 26%, according to Morgan Stanley), as public SaaS stocks have plummeted on concerns that agent AI could disrupt the software-as-a-service model.
Software is Apollo Debt Solutions BDC’s largest division, accounting for over 12%. Blue Owl also has significant exposure to SaaS financing.
black stoneBCRED, the company’s flagship private credit fund, also saw a sharp rise in redemption requests in the first quarter, but fell 0.4% in February, posting its first monthly loss in three years. The move comes after the fund wrote down a number of loans, including debt related to SaaS company Medalia, the FT reported.
But industry experts say that’s not the only pressure.
“Software exposed to AI is just the first fault line. The real risk lies across highly leveraged, interest rate-sensitive borrowers whose business models are set up on free money, especially in the US, where private credit has grown the fastest,” Haldea told CNBC in an email.
Barrett said funds concentrated in volatile sectors or holding less protected covenant-lite loans are also vulnerable, as are highly leveraged health care rollups. He highlighted certain smaller issuers that recently recorded a default rate of 10.9% due to a lack of shock-absorbing resources.
“Extreme” leverage
Brad Rogoff, global head of research at Barclays, said the current economic downturn has highlighted the need to better differentiate between investment-grade and sub-investment-grade private debt.
He said below-investment-grade credit typically has more “extreme” leverage, is often tied to software risk, and is concentrated in the United States.
In contrast, investment grade tends to include private senior tranches, asset-backed mortgages, and similar assets. “There’s a different risk profile between the two,” Rogoff told CNBC’s “Squawk Box Europe” on Tuesday.
black stone.
Mr. Rogoff noted that private credit funds are generally less leveraged today than investment banks were during the 2008 crash. “The real difference between this time and 2008 is that there was a lot of leverage over similar types of assets and it was totally dependent on the owner,” he said.
Despite the recent uproar over the liquidity mismatch between retail investors and semi-liquid vehicles, most private credit capital remains in traditional structures, supported primarily by institutional investors with long-term investment horizons.
Nicholas Ross, head of private markets advisory at UBP, said the current wave of redemptions represented the first real liquidity test of “massive scale” for the asset class.
He noted that default rates were “increasing but manageable,” but added that redemption pressures, slowing deal flows and market price volatility were simultaneously hurting the sector.
“The adjustment period will separate strong platforms with structural liquidity buffers from weaker platforms that rely on subscription momentum to fund exits,” Ross told CNBC via email.
