Private credit faces rising defaults and weaker returns despite upbeat outlook from managers
Private credit is showing mounting signs of strain, with defaults rising and more borrowers being placed on lenders’ watchlists, even as some of the industry’s largest managers maintain that concerns about the asset class are overstated, according to a report by the Wall Street Journal.
An analysis of recent quarterly disclosures from publicly listed vehicles managed by Ares Management, Blackstone, Blue Owl Capital and Golub Capital found that non-accruing loans have reached their highest levels in at least five years.
The deterioration comes after a period in which private credit became one of the fastest-growing areas of alternative investment, attracting capital with the prospect of relatively high and stable returns from lending directly to highly leveraged companies.
David Golub, co-chief executive of Golub Capital, described the current environment as a normal credit cycle rather than a systemic crisis, arguing that the market is likely to produce both winners and losers as borrower conditions diverge.
The proportion of non-performing loans at Blue Owl Capital Corp reached 2.8% in the second quarter, its highest level in at least five years. Comparable measures at Ares Capital Corp, Golub Capital BDC, and Blackstone Secured Lending Fund also reached five-year highs, according to company disclosures.
Those levels remain below the extremes seen during the Covid-19 pandemic and the 2015 oil-price collapse. Nevertheless, the deterioration is notable because it is occurring while the US economy remains relatively resilient.
Healthcare businesses and companies exposed to higher energy costs have so far accounted for much of the emerging stress. Investors are also increasingly focused on private credit’s exposure to software companies, many of which face potential disruption from artificial intelligence.
Software accounts for at least 20% of the loans at a number of private-credit funds, increasing concerns that a broader deterioration in the sector could translate into higher defaults across direct-lending portfolios.
Loan defaults are only part of the picture. Lenders are also monitoring a growing number of companies whose financial performance has deteriorated but which have not yet defaulted.
Funds managed by Ares, Golub and KKR have reported increases this year in the number of borrowers placed on watchlists for weakening credit quality. The levels are now the highest for those funds since the 2022-23 period, when rapidly rising interest rates put significant pressure on corporate borrowers.
Blue Owl has reported a different trend. Co-CEO Marc Lipschultz said the firm’s software exposure remained profitable and that there had been no meaningful change in its watchlist compared with the previous year.
For the wider market, however, expanding watchlists could be an early indicator of further defaults. The fact that credit stress is emerging while economic growth remains relatively solid could become more concerning if the US economy weakens.
Private credit managers are also contending with weaker investment performance.
Funds in the sector previously benefited from elevated benchmark interest rates and routinely generated annual returns of 10% or more. As rates have fallen and loan valuations have come under pressure, even stronger-performing vehicles are finding it harder to maintain those levels.
A KKR-managed fund, for example, recorded a 6.55% loss over the 12 months through June, although that represented an improvement from a 9.17% decline in the previous period.
Several factors are weighing on returns. Slower private equity dealmaking has reduced the supply of new loans carrying attractive yields, while weaker operating performance among borrowers has prompted lenders to mark down investments. Declines in public debt markets have also affected valuations, while falling benchmark rates are reducing interest income.
The combination of weaker returns and higher defaults could become particularly important for managers targeting individual investors. Retail and wealth-channel capital has been a significant source of growth for private credit, but investors who have become accustomed to relatively consistent double-digit returns could reassess their allocations if performance remains subdued.
That creates a potential feedback loop for the industry. Lower investor demand could make fundraising more difficult, reducing the pool of capital available to refinance existing private-credit borrowers as their loans mature.
