Interview, Fireside Chat
Private Credit Concerns in Context
- Private credit assets have grown to over $3.5 trillion, expanding at an approximate 15% annual rate for the last five years, yet sentiment has shifted sharply from bullish to bearish due to concerns over underwriting standards and sector exposure.
- Market anxieties currently center on three primary issues: the asset class's opacity, the untested nature of its credit quality through a full economic cycle, and liquidity constraints within retail-accessible funds.
- Software-related exposure represents a specific risk point, accounting for roughly 25% of the $1.6 to $1.7 trillion direct lending segment, though loan performance metrics like non-accruals and pick-or-payment rates have remained stable.
- Despite public software equities trading at discounts of 50% or more, private credit loans are insulated by Loan-to-Value (LTV) ratios of 30–40%, implying that 70% of company value must be erased before principal is at risk.
- Cumulative loss rates in the global financial crisis reached 10% with 50% recoveries for leveraged lending, contrasting with current spreads of 9–10% and zero reported defaults in the direct lending space to date.
- Retail investors account for less than 20% of private credit assets, meaning over 80% of the market remains insulated from immediate fire-sale pressure due to a lack of redemption mechanisms for institutional capital.
- Retail fund growth has slowed by approximately 50% compared to 2025 run rates, while first-quarter redemptions have accelerated to an annualized 10%, forcing a potential queue of exits.
- Most private credit funds impose 5% redemption caps, which Goldman Sachs Research anticipates will result in net outflows from retail vehicles extending through 2026 and 2027.
- Institutional direct lending faces compressed spreads due to high competition, but this may reverse in the next two years as reduced inflows and more attractive covenant terms draw capital from idle dry powder.
- Goldman Sachs analysts do not foresee a broad-based systemic crisis, citing the 5% redemption cap as a buffer and noting that industry liquid holdings and maturing loan volumes (approx. $40–45 billion) can cover estimated net outflows of $50–70 billion.
- Growth valuations for alternative asset managers, historically predicated on retail allocations rising from 1–3% to over 10%, are being re-evaluated, leading to slower projected fee growth for the sector.
- Opportunities may arise in dormant segments of private credit, including special situations, opportunistic funds, restructuring, and mezzanine capital, which have seen limited activity compared to the recent direct lending boom.
- Vivek Bhatnwal, Global Co-Head of Private Credit at Goldman Sachs, notes that AI disruption impacts vary by business model, with companies holding proprietary data or serving as critical "systems of record" showing greater resilience.
- BDC loan prices exhibit significant dispersion, with single-B names down roughly 9.5% and double-B names down 2.5%, indicating that credit markets are distinguishing between high-quality and vulnerable software credits.
- The illiquidity premium in private credit currently ranges from 150 to 300 basis points over public credit, a return that is only viable for investors who do not require short-term access to capital.
- Fraud and default anecdotes cited in recent media have not occurred within the direct lending BDC market, where the non-accrual rate sits at 1.54% for the top 20 issuers, compared to a 1.3% default rate in broadly syndicated loans.
- Goldman Sachs' own non-accrual rate is reported at 12 basis points, significantly lower than the sector average, though Bhatnwal warns of a specific caution regarding ARR (Annual Recurring Revenue) loans for non-cash-flowing software companies.
- A hypothetical severe scenario involving a 15% default rate and 50% recovery would result in a 7.5-point loss, which would reduce typical 10% returns to 2.5% but would likely be manageable relative to broader equity drawdowns.
- The path to restoring market faith requires continued strong earnings performance from portfolio companies, including double-digit revenue growth and improving fixed charge coverage ratios, alongside a widening of spreads to incentivize new capital.