Transcription
So Fitch just reported a record high for private credit defaults. That would seem to validate what most people think: that the credit downturn is contained inside just private credit. And that's understandable. The most visible warnings have come from there: the record defaults, rising nonaccruals, restricted withdrawals, weaker fundraising, and falling BDC company stocks.
But the word "private" is becoming dangerously misleading because the same concern is now showing up in public markets. Spreads on triple C-rated junk bonds have pushed past a thousand basis points. These are levels seen at the worst of last year's tariff panic or 2024's carry trade blow-up. There is some serious flight from risky junk, same as investors continuing to sell private credit BDCs, pushing those stock prices to new lows recently. And all of it belies the idea that the broader marketplace is stable or stabilizing. It isn't. We keep finding more signs of stress spilling over. After all, I just went over the bonds connected to artificial intelligence and the buildout there that were meeting resistance and the sharp rise in credit-to-default swap prices for major AI-related companies. These markets are all looking at different pieces of the same credit market cycle. Now, private credit is where most of the noise has been, understandably, but that's not the extent of the downturn. Instead, public markets are starting to do some price discovery, and what they're discovering are a lot more cracks across the entire credit market edifice.
So, let's start with what's happening in public credit. Now, a credit spread measures how much additional yield investors demand to own corporate debt rather than a safer government bond. When spreads are narrow, investors are confident about repayment, about economic growth, market liquidity. And when spreads widen, investors want more compensation for risk. And right now, the headline signal looks deceptively calm. Investment grade spreads remain historically low. Even the stronger sections of the high yield market haven't yet experienced the kind of indiscriminate selling that normally associates with a major credit market event. But move down to triple C's, or the "triple hooks" as they're called, and the picture changes completely. Triple C spreads have crossed a thousand basis points this week. That's not a small adjustment. It represents an active refusal by investors to accept the resilient economy story where balance sheets are there at their weakest. It's one thing to talk the talk and hold an investment-rated corporate bond. It's another to agree with the Fed's public position, but then put your client's money on it with riskier debt. Triple C-rated businesses often have limited liquidity, weak interest coverage, and frequent refinancing needs. Many can survive only if capital markets remain open and lenders remain willing to extend maturities. So, this is a warning sign from the public market that investors are indeed getting pretty nervous. Public credit is therefore not saying everything is fine. It is saying stronger companies, they appear to be okay, at least for now. But investors no longer want to finance the weakest companies without being paid crisis-like compensation. And that flies in the face of both narratives: that the market is generally on board with the mainstream view of the economy as, you know, not great, but hanging in there, at least with a more positive outlook, and that the private credit mess is contained to just private credit. The economy has more worries, and privates are becoming more public.
And that public market avoidance makes more sense when you look under the hood at what's going on in private credit. The one is definitely feeding into the other, which was always the big risk. Fitch Ratings tracks approximately 1,300 American private debt borrowers. And according to its latest report, which just came out, the trailing 12-month default rate reached a record 6% at the end of the second quarter. That was up from the previous record of 5.7% only three months ago. Fitch recorded 32 private credit default events during the quarter involving 20 new unique defaulters. And that total number of defaulters reached 84. But the most important detail is how these borrowers defaulted. Maturity extensions under stress became the leading source of delinquency, overtaking PIK, or payment-in-kind arrangements, or other kinds of interest rate deferrals. More than half of the quarter's default events included some form of maturity extension. In other words, the problem is increasingly moving from expensive interest payments to the inability to repay principal on schedule. An extension can prevent a conventional bankruptcy, but can also allow a lender to avoid recognizing the full severity of a problem immediately. But extending a maturity doesn't create cash flow; it just moves the deadline. Fitch also said industrials and manufacturing had the highest private credit default rate at 10.4%, up from 5.9% in the first quarter. So, there's your commentary on the stability or resilience of the macroeconomy. These are not isolated accidents. They indicate stress across sectors filled with leverage middle-market borrowers. The same type of lower-quality corporate risk that public triple C investors are now themselves also avoiding.
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And this warning in the public site of the marketplace also extends into other places besides just junk bonds and junk bond indexes. As we talked about recently, they're having trouble selling bonds among some of the biggest names in the AI hyperscaler buildout. For the first stage of the AI boom, investors concentrated on stock. Now the buildout is becoming a debt market story. AI-related borrowing has accelerated as technology companies, data center developers, and infrastructure funds all compete for chips, electric equipment, construction capacity, and of course, power. Even companies with enormous cash flows are borrowing because the scale of the expected spending is so large, and it gets larger every single quarter. In credit markets, they're beginning to question all of it, from the projections to the pathway forward. Oracle, their five-year credit default swap spread recently reached approximately 215 basis points, which was compared to 145 at the end of last year. SpaceX, that protection reached 185 basis points after rising sharply since trading began. In fact, there were CDS prices even before there were bonds to be traded. And then, same thing, credit default swaps with Nvidia, Meta, Amazon, Alphabet, they've all moved higher in July. Now, a rising credit default swap spread doesn't mean default is imminent. These companies are not equivalent to the distressed triple C borrowers we just talked about. But what it does mean is that investors are paying more to protect against outcomes they previously considered remote, when they even considered them at all. And that same behavioral change has appeared in bond issuance. Amazon sold $25 billion of bonds across eight maturities. And the initial orders, they were about $62 billion, seemed really well. But after the offered spreads were reduced, the order book fell to around $41 billion, which was enough to complete the deal, but less than twice the amount that was issued. And again, that was much less than the average for investment grade offerings, which are around four times the offer size. And Amazon reportedly had to pay an elevated new issue concession on some of its longer-dated maturities. So, Amazon got the money, but the warning again: investors no longer willing to provide it at almost any price or without asking key questions.
But now, go back to private credit, where some of this AI-related stress is showing up in the worst possible way in terms of nonaccruals in some of these private credit portfolios. Ares Capital, the largest publicly traded BDC, reported that investments on nonaccrual status rose to $78 million during the second quarter. That was an increase of 15% from the previous quarter and up 26% from a year earlier. A loan goes on nonaccrual when the lender no longer expects to receive interest normally enough to recognize that interest as income. It's a much more serious signal than an ordinary mark-to-market decline. It says they're losing faith in the ability of the borrower to pay it back. Now, to be fair, Ares said nonaccruals were approximately 2.4% of the portfolio at cost, which was still below its roughly 3% historical average. So, it doesn't mean Ares itself is in danger or the portfolio is exploding with defaults. But the direction matters, especially right now with all of these questions swirling. The amount of troubled credit is rising, and net asset value per share slipped from $19.59 to $19.35. All as the industry is confronting borrowers whose business models may be weakened by AI and other things like the macroeconomy. So, you've got many private credit portfolios that are financing software, IT services, call centers, healthcare administration, and other businesses once considered stable and predictable. That predictability justified their investments and all this leverage. But if AI reduces the value of a software product or automates a service, maybe it allows a competitor to operate at a much lower cost, yesterday's stable recurring revenue can become tomorrow's refinancing problem. That connects directly to the public AI bond story. One side of the market is borrowing hundreds of billions to build AI infrastructure, and the other side is discovering that existing businesses are going to be disrupted by it. And credit investors are exposed to both sides of the bet, when it is entirely possible that neither side fully pays off.
So, this brings us back into the publicly traded market and that kind of weird area in between public and private. I'm talking, of course, about the stocks of the BDCs themselves. So, private credit portfolios that are traded publicly on the public stock market. Business development companies make loans to smaller and middle-market businesses, often in the same private credit ecosystem that's difficult for outsiders to observe. So, the loans may be private, but the BDC stocks are public. So, we do get some indirect price discovery on those private credit portfolios as a whole. And those stocks, they have been falling again. Vehicles associated with some of the biggest names in private credit, from Blue Owl to Goldman Sachs, they've been moving toward new lows. Investors are applying larger discounts because they're questioning future earnings, dividend coverage, the portfolio marks, the models, and recovery values. Now, a falling BDC stock doesn't automatically prove that its reported NAV is wrong. Equity prices can certainly overshoot; we've seen that before, time and again. But this has been going on for over a year, and the stock market is clearly demanding a margin of safety that the private portfolio marks just aren't showing us. That makes BDCs a bridge between the private and public systems. Inside the fund, a loan might be marked down gradually after a quarterly valuation process, but in the stock market, the entire vehicle can be repriced every second. The BDC investors, therefore, are asking several questions at once: How many borrowers will stop paying? How many have already stopped paying? How many will receive maturity extensions? How much interest income will be converted into PIK debt? And what happens to the dividend if nonaccruals keep rising? Public BDC prices aren't separate from private credit stress; they are the public market's real-time estimate of that stress.
And of course, we're not going to go through public and private credit, the credit cycle overall, without bringing in Blue Owl, because we got more reporting from Blue Owl, which shows, I mean, we already know about the redemptions that are taking place at the funds. But on the other side of the account, fundraising, the amount of money coming in, according to Blue Owl, has really dried up. The firm raised just $7.6 billion during the quarter, which was down from $12.1 billion during the same period a year earlier. More importantly, fundraising in specifically its credit business fell to just $1.8 billion, about one-third of the amount raised a year ago, and the lowest level in three years, back to when the boom was still in its infancy. Blue Owl also, as we know, limited withdrawals from two private credit funds after receiving the industry's highest redemption request for a second consecutive quarter. These funds that offer periodic liquidity, like Blue Owl's, they own assets that could take months to sell, assuming an incredible market price exists at all. If too many investors request their money simultaneously, the manager has to restrict the withdrawals. It has to raise cash or sell assets at unattractive prices. Those are the stage two, stage three behaviors. So, this explains why fundraising matters so much. Fresh capital provides the fund with flexibility. It can fund new loans, support existing borrowers. It can help meet the redemptions and reduce dependence on forced asset sales. But when fundraising slows while the withdrawal requests rise, that flexibility declines, if not disappears. And again, this is key stage two confirmation. Stage two is when doubts spread beyond existing investors trying to get their money out to potentially new investors who take a look and decide never to put their money in in the first place. The problem is not necessarily an immediate collapse; it is that private credit's ability to absorb its own troubled loans becomes weaker just as default rates are reaching a record high.
Now, naturally, the question is, if all this is happening and starting to spill over into public markets, why are we seeing record low or near-record low spreads on the investment grade side? And the answer starts with: because credit cycles rarely hit every borrower simultaneously. There's always this type of sorting and tiering. Large investment grade companies usually have better access to cash, longer-dated debt, more diversified revenue, and less urgent refinancing needs. Their bonds also benefit from pension demand, insurance company buying, passive funds, and a limited net supply. Those technical flows can keep spreads compressed even as fundamental concerns grow elsewhere. The important mistake is assuming tight investment grade spreads somehow cancel the triple C, triple hook warning. They don't. The divergence tells us investors are becoming more selective rather than universally risk-averse. They want credit exposure, but they prefer borrowers capable of surviving at least slower growth and tighter financing conditions. And I don't mean higher interest rates. The weakest companies are losing access first. That's what happens in these cycles. That's how many credit cycles begin: not with every market collapsing together, but with lenders withdrawing from borrowers that require continuous refinancing. Once spreads exceed a thousand basis points, some triple C companies effectively lose normal market access. They could turn to private lenders or maybe exchange debt or sell some assets. But private lenders are already reporting record defaults, rising nonaccruals, slower fundraising, and redemption pressures all their own. The supposed escape route from public credit is therefore becoming constrained at exactly the same time, because that's what happens in credit cycles.
And there's another big reason why private credit stress is not likely to remain private exclusively, and that is the role of regulated banks in this entire ecosystem. The Financial Stability Board says its member data captures approximately $220 billion of drawn and undrawn bank credit lines to specifically private credit funds. Commercial estimates suggest the amount could be more than twice that much. And relative to total bank assets and capital, these exposures are manageable. They're not really huge, but the uncertainty here, that's what's significant. And direct credit lines are only one connection. Banks provide borrowing-based facilities against portfolios of private loans. So, banks, they need to be willing to fund these things in order for these funds to continue operating. The banks provide revolving credit facilities to the companies that also borrow from private credit funds. So, they're on both sides of it here. The banks participate in strategic partnerships with asset managers. They hold senior tranches in some of these financing structures that are supported by pools of middle-market loans. The borrowing-based facility depends on eligible collateral. If loans deteriorate, the collateral values can be reduced, and that can produce a borrowing-based deficiency, forcing a fund to contribute cash, add more collateral, or repay part of the facility at a time when the fund really can't afford to repay it. This is the transmission mechanism, the liquidity part of it. Private borrowers miss payments or extend maturities. Funds mark the loans down. Banks advance less against those portfolios. Liquidity dries up. So, BDC earnings weaken. Investors demand wider discounts in the public market. Public junk bond buyers see deteriorating recovery and free financing conditions and require even wider spreads. No single connection needs to be catastrophic, but altogether, they make the description "private credit" increasingly inaccurate. The loans may not trade publicly, but their leverage, the funding, and the valuations are connected to public institutions and public market prices.
Now, with the triple C's crossing that magical 1,000 basis point threshold, it doesn't guarantee something like a traditional recession or financial crisis. That's not the signal we're actually getting here. The signal that we're really homing in on is what it means as far as specifically the broader credit market cycle. That signal tells us something more precise: Market participants are actively avoiding the riskiest public credit. And that matters because credit investors care less about whether a company has an exciting story and more about whether it can make the next payment, refinance at the next maturity, and preserve value during that entire restructuring process. The AI credit signals reinforce the same shift. Even prestigious borrowers are encountering more price sensitivity. Investors are purchasing protection before even new bonds arrive. At the bottom of the market, companies are being charged yields that can make refinancing impossible. Meanwhile, private lenders are extending maturities, they're restricting redemptions, they're reporting now higher nonaccruals, and even raising less new money. These are not separate narratives; they are different stages of the same repricing, from concern about private marks to falling BDC stocks to wider triple C spreads to higher credit-to-default swap premiums and more difficulties for public bond offerings. So, the popular story says the downturn is a private credit problem. The evidence says the word "private" describes where many loans are held, not where the consequences end.
Fitch's private credit default rate has reached a record 6%. Industrials, manufacturing, and some healthcare are showing especially high stress. Maturity extensions, that's a key; they've replaced simpler payment deferrals as the leading source of default. Ares reporting higher nonaccrual loans. Blue Owl's credit fundraising has fallen sharply while redemption requests have forced withdrawal limits. BDC stock prices are reflecting even worse investor doubts about portfolio values and future incomes. And now, the public credit market is also responding. The triple hooks above a thousand basis points show that investors are withdrawing from the weakest borrowers. AI-related credit default swap prices and the bond offerings show growing caution even among the stronger names. Investment grade spreads remain calm, but that calm is increasingly concentrated among borrowers least exposed to immediate refinancing pressure and macroeconomic conditions. It's not proof of a systemwide crisis, but it is proof that the credit cycle, at the very least, is no longer confined to private portfolios. Private credit supplied financing when public markets and banks were unwilling to do so. But now, private lenders face their own defaults, liquidity limits, and funding constraints. Public markets are noticing. And when markets start asking who can really refinance, which collateral can be trusted, and which valuations are real, the problem is no longer private. It is simply credit.
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