The Private Credit Reckoning - Executive Summary

In our October report on “The Retailization of Private Markets”, we presented a bearish case for private credit. We saw mounting evidence suggesting that skyrocketing AUM over the past decade had led to both deal quality erosion and deal convolution. With the implosions of First Brands and Tricolor, we recognized a catalyst for a sentiment reversal. As we wrote at the time: “Complacency is the greatest risk in private credit markets. Proceed with caution and most of all, rigor.” We recommended reduced exposure to private credit, a lean towards higher-quality debt with the remaining exposure, and avoidance of retail-targeted funds. Since publishing that report, mounting evidence has turned to accelerating pain. In 1Q26 alone, private credit funds saw $20.8 billion in redemption requests from investors, trouncing the previous record for quarterly redemptions set in 4Q25 (roughly $6 billion). That pace of redemptions forced marquee funds managed by everyone from Blue Owl and Apollo to Ares, Cliffwater, and KKR to enforce 5% redemption caps, freezing withdrawals. Cataclysmic headlines have followed, often reflecting the same fear: private credit as a GFC-level threat.

Yet, throughout the YTD run on private credit funds, our contrarian nerve has been tweaked by the turmoil’s widely-credited instigator: fear about AI-driven software company obsoletion. One market-moving February report from UBS argued that private credit default rates could surge as high as 15% if artificial intelligence triggers “aggressive” disruption among software borrowers.

Yet, we maintain conviction in what we argued in our December report on “GenAI & Productivity”: market participants are underestimating barriers to transformational enterprise adoption and therefore, overestimating the timeline to large-scale disruption across sectors. Moreover, domain expertise will be essential as companies seek guidance in their AI transformations, and many software companies will be well-positioned to provide that guidance. Of course, AI will trigger creative destruction in the software sector, but the same can be said for pretty much all sectors. Whether it’s private markets or public markets, we’ve seen the YTD software sell off as a selective buy opportunity—a chance to increase exposure to software companies with durable moats and growth tailwinds.

To date, private credit turbulence has been driven far more by sentiment than fundamentals. The headline-dominating problems at business development companies (BDCs)—and the pain for shareholders of Blue Owl, Ares, Apollo, etc.—is rooted less in loan portfolios in crisis than fear running headlong into misguided liquidity expectations about “semi-liquid” retailized products. Yes, there have been marquee blowups by the likes of First Brands, Tricolor, MFS, and most recently, Medallia. However, the overall private credit default rate has only ticked up slightly, hitting 6% in April after hovering around 5.5% for the past six months, according to Fitch.

To our mind, software is more a microcosm of private credit’s broader weaknesses than a single point of failure. First, there’s the deal quality erosion problem, which peaked with pandemic-era excessive enthusiasm, leading to everything from looser covenants and creative EBITDA addbacks to elevated leverage multiples. Software companies were the epicenter of that erosion; however, it was certainly not exclusive to the sector. Meanwhile, private credit does have a concentration problem, but it’s broader than just software. Asset-light businesses account for a far higher percentage of private credit relative to public credit (chart below on the left), which could translate to less reclaimable value in the event of default, whether instigated by AI disruption or otherwise. Finally, private credit has a duration challenge, with a debt maturity wall looming—approximately 17% of all private credit loans are set to mature in the next two years, according to BofA. Software accounts for a high percentage of those maturities (chart below on the right), but it is by no means the only sector that could pose refinancing challenges if inflation continues to keep benchmark rates higher-for-longer and private equity and private credit fundraising dips.

The headline default rate may appear relatively benign, but digging below the surface tells a story of mounting vulnerability. For one indicator of pent-up default risk, “bad PIK”—payment-in-kind provisions added mid deal to help alleviate stress on borrowers—has been on the rise, more than doubling in four years, from 2.5% of all deals in 4Q21 to 6.4% by 4Q25, according to Lincoln International. Meanwhile, private credit returns are deteriorating, which could challenge fundraising. For one, late last month, Blackstone reported that its private credit strategies averaged returns of 5.7% over the past 12 months, a sharp decline from the 10.8% yield recorded in the prior 12-month period.

In an April memo, Oaktree’s Howard Marks summed up the progression that led to private credit’s current weakness:

The massive amounts of capital that have been available for investment in direct lending created a goldrush mentality. In the last 15 years, something like $2 trillion of direct loans have been made. (The whole private credit sector was only about $150 billion 20 years ago.) Thus, I imagine some direct lending managers accepted too much money and invested it too fast, applying standards that were too low and setting the scene for a correction.

Yet, too often in today’s fixation on private credit’s weaknesses, the bigger-picture risk is neglected. In and upon itself, we do not see private credit as a systemic risk. At an estimated $1.8 trillion in the US as of year-end 2025, private credit remains a relatively small part of the financial system. As in the case of Medallia—which Thoma Bravo turned over to creditors in April—some value can be reclaimed by lenders if defaults spike, limiting losses. Even the challenges faced by BDCs can be construed as funds working as they were designed to work, restraining redemptions to prevent forced selling that could crater asset values regardless of fundamentals.

To our mind, private credit is more a canary in the coal mine than a systemic threat in and upon itself. The below chart reflects one key reason why. Verdad Advisors looked at the return of high-yield bonds to the matched public equities for every notch deterioration in credit over the last 20 years. The equity returns were always worse than the debt returns at each downgrade level. Unsurprisingly given their symbiosis, private equity possesses much the same vulnerabilities as private credit—pandemic-era malinvestment, overly concentrated exposure, and widespread “kick-the-can” tactics that have delayed a full reckoning with this downcycle, likely storing up pain. US private equity AUM is more than double US private credit AUM. Today, private-equity-backed companies account for roughly 8% of US employment. Market participants are neglecting that private credit’s challenges are likely evidence of more significant challenges brewing in private equity.

What we fear is that turbulence in private credit YTD is a warning shot for tighter financial conditions to come. This is particularly concerning at a time when the US debt burden is ballooning and the war in Iran threatens stagflation amidst persistently higher energy prices. As of writing this, Goldman Sach expected Brent crude at an average of $90 per barrel in the fourth quarter of the year while JP Morgan expected that number to remain above $100 through the end of the year. It is also concerning given increasing signs of US consumer fragility, from record-high credit card debt and rising auto and student loan delinquencies to a savings rate hovering near a record low. And it is concerning given elevated valuations across asset classes. In this era of unprecedented financialization, main street and Wall Street have never been more intertwined.

The Iran war and the resulting inflation surge have recently spiked bond market fear, causing financial conditions to tighten, with the 30-year Treasury hitting its highest rate since 2007. As of writing this, the spread between the 30-year Treasury yield and the Effective Federal Funds Rate sat at 156 basis points. This will put pressure on the Fed to turn hawkish. And any significant and sustained tightening threatens a credit recession carrying more severe and widespread implications than many anticipate today.

We see compelling reason to believe credit-recession fear could increase significantly over the second half of this year. Private credit’s turbulence merits deep scrutiny as an early indicator of broader stress to come. So, we dug in, reviewing everything publicly reported and the analysis of asset managers, banks, academics, and ratings agencies. How do investors mitigate the risk that private credit turbulence intensifies significantly? What follows encapsulates how we see that question today.