Private credit's latest headache

Just when you thought private credit’s woes were over, they’ve returned—and they’re worse than ever.

Recent quarterly reports from funds overseen by Ares Management, Blackstone, Blue Owl Capital, and Golub Capital hit their highest levels of default since at least 2021, according to a Wall Street Journal analysis. At Blue Owl, 2.8% of loans were in default in the second quarter—its highest share in at least five years—while nonperforming loans at the other three managers also reached five-year highs.

Much of the concern over the health of private credit firms has centered on their investments in software companies suddenly vulnerable to AI disruption, which account for more than 20% of the loans in many private credit portfolios. But the recent trouble has surfaced elsewhere: highly leveraged manufacturers and healthcare companies getting squeezed by higher oil prices.

Those companies are being added to what private credit firms call “watchlists”—borrowers they’re concerned may struggle to repay their debt. At Ares, Golub, and KKR, those watchlists are now the largest they’ve been in roughly four years.

Back to the banks

Defaults aren’t private credit’s only headache. The industry is also losing ground to the very banks it spent the last decade taking business from.

Years of higher-for-longer interest rates have left heavily indebted companies paying hefty interest on their private credit loans. As a result, many are now rushing to refinance with cheaper syndicated bank loans whenever they can. In fact, companies are moving from private credit into bank loans about three times as often as borrowers are going the other way, according to JPMorgan and KBRA DLD data.

That shift is starting to show up in returns. Private credit funds that used to generate annual gains of 10% or more are now struggling to deliver even 7%. Banks, meanwhile, are benefiting from the refinancing wave: Commercial and industrial lending—the traditional business loans that banks make to companies—grew at a 14.2% annualized pace in the second quarter, up from just 4.4% a year earlier.

One silver lining: A cooling labor market has reduced expectations for additional Fed rate hikes. That lowers the risk of borrowing costs climbing even higher for the indebted companies held in many private credit portfolios. But private credit funds are stuck in an uncomfortable reality: They’re being squeezed from both ends as weak borrowers fall behind, while many of their strongest borrowers are leaving altogether.—SY