Private Credit Panic - Why Investors Are Rushing For the Exits

Over the past decade, a massive lending machine has been constructed outside the traditional banking system. Often referred to as "shadow banking" or non-bank financial intermediaries (NBFIs), this sector—specifically private credit—has become the "hot new thing" on Wall Street. Private credit involves non-bank institutions lending money directly to private businesses. However, with minimal oversight compared to traditional banks, recent months have revealed significant cracks in this $2 trillion market, ranging from borrower defaults to a rush of investors attempting to withdraw their capital. ### The Genesis and Growth of Private Credit Private credit is essentially the lending equivalent of private equity. Investment firms raise capital from investors to lend to private companies, charging significant fees while passing returns back to their clients. Since 2009, the industry has grown tenfold. This rapid expansion was fueled by the regulatory aftermath of the 2008 financial crisis. As traditional banks were hit with stringent regulations that restricted risky lending, they shifted toward safer assets like Treasury bonds. Private credit firms stepped in to fill this gap, offering higher returns—such as Blackstone’s flagship fund yielding nearly 10% annually—at a time when traditional bonds offered very little. ### Signs of Trouble: Defaults and Fraud The industry’s recent "reckoning" began in September when two major companies, Tricolor (a subprime car lender) and First Brands (a car parts supplier), declared bankruptcy with combined debts exceeding $10 billion. These collapses were alarming not just because of their size, but because of the speed at which their valuations plummeted. In the case of First Brands, the company had received a "clean bill of health" in an audit just six months prior; its debt value crashed from 100 cents on the dollar to below 20 cents almost overnight. Executives at both companies have since been charged with fraud, specifically for "double pledging" assets as collateral. These incidents have raised serious questions about the due diligence and lending standards of private credit firms. As JP Morgan CEO Jamie Dimon noted regarding the Tricolor hit, "When you see one roach, there’s probably more." This sentiment was validated by subsequent write-offs from major players like Apollo Global Management and BlackRock, signaling a concerning trend of rising defaults. ### The Liquidity Crisis and "Gating" As concerns grew, a wave of investors sought to exit the market, leading to record-high redemption requests. Because private credit involves illiquid loans with no secondary market, funds cannot easily sell assets to pay back investors. Consequently, many major funds have "gated" redemptions—essentially trapping investor money to prevent a disruptive "fire sale." For example, Blackstone’s $83 billion BCred fund saw redemptions hit 7.9% of its holdings, while Blue Owl Capital temporarily restricted and then completely halted redemptions for one of its major funds. While gating is a standard mechanism in private markets to protect long-term strategies, the friction is intensified by the industry’s recent push into the retail space. Through 401(k)s and platforms like Robinhood, individual investors now have more access to these alternative assets, creating a mismatch between investor expectations for liquidity and the reality of private lending. ### Structural and Macroeconomic Risks Beyond individual defaults, several fundamental issues plague the sector. Private credit has an outsized exposure to the software industry, which is currently facing disruption from AI. Software loans often feature high leverage and low coverage ratios, and a "wall of maturities" is approaching, with 31% of this debt coming due in the next two years. Furthermore, the macroeconomic environment has turned hostile. Most private credit loans are floating-rate, meaning higher interest rates are passed directly to borrowers, increasing their risk of insolvency. The opaque nature of the market adds another layer of risk; because there is no public price discovery, valuations rely on appraisals. This creates an incentive for funds to keep valuations high to maintain fees, leading to "rapid write-offs" when reality finally catches up. Some funds have even resorted to "payments in kind" (PIK), allowing struggling borrowers to pay interest with more debt rather than cash, which only delays an eventual default. ### Systemic Risk: A Repeat of 2008? While these red flags are reminiscent of the 2008 financial crisis, there are key differences. Private credit is less ingrained in the broader financial system than mortgages were in 2008. There is no massive derivative market stacking exposure on top of these loans, and bank exposure—while existing—is relatively small. For instance, Barclays has the highest dollar exposure to these loans, yet they represent only 6% of the bank's total loans. However, the risks are not negligible. Private credit is a primary lender to small and medium-sized businesses. Turmoil in this space could reduce credit availability, hurting business growth and employment. Additionally, banks have lent approximately $300 billion to these private credit funds. If the funds lose money, the banks that financed them could feel the impact. ### Conclusion The private credit market is currently at a crossroads. While some data points suggest the market remains resilient—such as high-yield spreads remaining relatively low and many loans continuing to perform—the lack of transparency makes it difficult to gauge the true level of risk. Whether this is a contained "reckoning" for a few risky funds or the start of a more systemic issue remains to be seen. For now, while it may be too early to claim another Great Financial Crisis is imminent, the "cracks" in the private credit machine are impossible to ignore.