Private credit is confronting its most significant challenge in roughly a decade. Data analysis reveals that the proportion of non-accrual loans, which are problem loans, at some of the largest publicly traded private credit funds has climbed to near-decade highs. The last time such levels were seen was during the oil price crash when energy companies were under severe stress. Simultaneously, funds are writing down the value of their portfolios and issuing warnings about an increase in troubled loans. This trend is unfolding against the backdrop of a broadly resilient US economy, drawing heightened market attention to asset quality.

Where the Strain is Showing

An examination of the largest publicly traded private credit funds shows a rapid increase in the ratio of non-accrual loans. These are assets from which the fund may not be able to recover the full principal or interest. The industry engaged in a significant lending spree during the private equity boom of 2020-2021, a period characterised by high valuations and near-zero interest rates, which allowed companies to take on substantial debt burdens. Now, with interest rates significantly higher and the health of the software sector, a key area for private credit investment, under scrutiny, some companies are finding it impossible to service their debts normally. In some cases, private equity sponsors are even "handing back the keys" of certain companies to lenders, a disappointing outcome for both parties. Major managers, including funds associated with Ares, Blackstone, Blue Owl, and Golub, have seen their default or non-accrual rates reach at least five-year highs. The pressure is particularly acute in the software and healthcare sectors, as well as among highly leveraged borrowers affected by oil price volatility.

Industry Response and Internal Sentiment

In response to the pressure, some funds have noticeably scaled back their underwriting of new loans. They are even proactively selling off loans, especially those with exposure to the software sector, to cut losses. Industry insiders reveal this is because the associated risks are generating excessive negative attention, which could jeopardise their larger ambition of packaging private credit loans for sale to insurance companies, pension funds, and sovereign wealth funds. Meanwhile, some executives are emphasising to investors that concerns may be overstated, arguing that the majority of loans are still performing well. The media coverage of the issue has also drawn criticism from within the industry, with some accusing it of creating a "panic".

Is There a Systemic Risk?

Currently, neither the market nor regulators are viewing this as a systemic financial risk. Regulatory bodies continue to monitor the connections between private credit and the broader financial system but have not yet sounded the alarm. The problems appear to be more concentrated on the refinancing and maturity pressures of loans issued during a specific cycle, rather than an immediate threat of contagion to the entire system.

Market Interpretation and the Path Forward

The market interprets this period of stress as having a distinct lagged effect: the highly leveraged buyouts of 2020-2021 are now entering their repayment and repricing windows, coinciding with a changed interest rate environment and fundamental challenges in sectors like software. For investors, the key metrics to watch are the non-accrual rate, the magnitude of write-downs, and redemption pressures, with some semi-liquid products already seeing elevated redemption requests. In the short term, this could weigh on the valuations of related BDCs and private credit funds. Over the medium to long term, it will test the risk control and asset management capabilities of fund managers. If the US economy slows down or interest rates remain higher for longer, the pressure is likely to increase. Conversely, if the fundamental conditions improve in key areas like software, some of the problem loans may be gradually resolved. The current signals are clear enough: private credit has moved from being a "hot asset class" into a genuine stress test phase.