Declining asset quality, collateral reductions, and an increasing exodus are unsettling private credit markets, leading to parallels with the Global Financial Crisis.
Nonetheless, a rise in loan defaults, although challenging, may help eliminate stress from the $3 trillion sector and offer what one industry expert describes as a “beneficial reset” following its first significant liquidity trial.
Ares Management on Tuesday decided to restrict investor withdrawals from its $10.7 billion private credit fund, just one day after Apollo Global Management revealed similar actions in one of its funds. Ares has limited redemptions in its Ares Strategic Income Fund to 5%, after withdrawal requests reached 11.6%, as reported by Bloomberg.
Other managers, such as Blue Owl Capital and Cliffwater, have also rushed to halt or limit withdrawals in recent weeks, as rising default anxieties trigger an investor exodus from the sector.
Parallels to the run-up to the 2008 Global Financial Crisis are becoming more pronounced as worries about intrinsic loan quality increase.
Morgan Stanley recently cautioned that default rates in private credit direct lending could spike to 8%, significantly higher than the 2-2.5% historical average, with pressure focused in sectors susceptible to AI disruptions, including software.
‘Significant but not systemic’
However, analysts at Morgan Stanley led by strategist Joyce Jiang also stated that an 8% default increase would be “significant but not systemic,” noting the reduced leverage among private credit funds and business development companies compared to 2008.
What would a default surge of this scale mean in practical terms?
“An 8% default rate transitions private credit from a ‘zero loss’ illusion to a more conventional credit asset class — painful in certain areas, but ultimately a constructive reset that releases capital for more resilient businesses,” remarked Sunaina Sinha Haldea, global head of private capital advisory at Raymond James.
She mentioned that normalizing from ultra‑low defaults would be “painful for some funds” but “beneficial for the asset class if it necessitates improved underwriting and more accurate valuations.”
An 8% or 9% default rate would predominantly present through what are termed “shadow defaults,” such as maturity extensions and covenant waivers, explained William Barrett, managing partner at Reach Capital. Lenders utilize these “amend-and-pretend” techniques to support borrowers and avert immediate insolvency.
While payment-in-kind arrangements defer cash returns, amplify debt, and could indicate greater system stress, they also function as an effective “release valve” that stabilizes firms and prevents outright failures, he added.
“For the real economy, this implies that capital becomes ensnared in restructurings, resulting in tighter future lending conditions,” Barrett informed CNBC via email.
Pressure points
Concerns regarding credit quality have spread across private markets following the notable collapses of First Brands and Tricolor in the U.S. auto parts industry the previous year. Although those failures were associated with asset-based finance and bank-syndicated loans rather than traditional middle-market direct lending, they raised broader concerns about risky debt in private markets.
Focus has since shifted to software exposure in direct lending — estimated at roughly 26%, according to Morgan Stanley — after apprehensions that agentic AI could disrupt the software-as-a-service model sent publicly-traded SaaS stocks tumbling.
Software constitutes the largest sector in the Apollo Debt Solutions BDC, accounting for over 12%. Blue Owl is also significantly exposed to SaaS lending.
Blackstone‘s leading private credit fund BCRED, which experienced a rise in redemption requests during the first quarter, was down 0.4% in February, marking its first monthly decline in three years. This occurred as the fund revised down several loans, including debt related to SaaS company Medallia, according to a report from the FT.
However, these are not the singular pressure points, industry experts assert.
“AI-exposed software is merely the initial fault line — the actual risk extends across any high-leverage, rate-sensitive borrower whose business model was designed for easy capital, particularly in the U.S. where private credit expanded quickly,” Haldea told CNBC via email.
Funds focused in volatile sectors or holding covenant-lite loans with reduced protections also face risks, as do highly leveraged healthcare consolidations, Barrett noted. He singled out various smaller issuers that are currently seeing a 10.9% default rate due to insufficient resources to absorb shocks.
‘Extreme’ leverage
The current distress underscores the necessity to better differentiate between investment-grade and sub-investment-grade private debt, according to Brad Rogoff, global head of research at Barclays.
Sub-investment-grade credit generally entails more “extreme” leverage, frequently associated with software risk and concentrated in the U.S., he stated.
Investment grade, in contrast, usually encompasses private placement senior tranches, asset-backed mortgages, and similar assets. “There exists a different risk profile between the two categories,” Rogoff told CNBC’s “Squawk Box Europe” on Tuesday.
Today, private credit funds are generally less leveraged than the investment banks that were involved in the 2008 crash, Rogoff pointed out. “The key distinction between now and 2008 is that there was substantial leverage on similar types of assets that had full recourse for their owners,” he said.
Despite the recent concerns surrounding the liquidity mismatches between retail investors and semi-liquid vehicles, the bulk of private credit capital remains in traditional frameworks, primarily supported by institutional investors with long-term investment objectives.
Nicolas Roth, head of private markets advisory at UBP, stated that the ongoing wave of redemption requests represents the first genuine liquidity evaluation for the asset class “on a significant scale.”
He remarked that default rates are “high but manageable,” yet indicated that redemption pressures, declining deal flow, and mark-to-market variability are concurrently impacting the sector.
“The adjustment phase will distinguish robust platforms with structural liquidity buffers from weaker platforms depending on subscription momentum for financing exits,” Roth informed CNBC via email.
