A few weeks ago, analysts at UBS Group painted the worst-case scenario for defaults in the private credit space. Now, their outlook is even more pessimistic.
Strategists including Matthew Mish now say that the default rate on private credit could soar to 15%, two percentage points higher than the forecast the firm issued less than a month ago.
The initial report warned that direct lenders could face a 13% default rate if AI triggered “radical” changes among corporate borrowers, but in recent weeks, as concerns have deepened over AI’s potential to upend the US economy, this view has become even more pessimistic.
The report released on Tuesday stated: “The new variable is a more explicit catalyst – the rapid and severe disruption brought about by artificial intelligence.”
In recent days, concerns over such events have been escalating. At the beginning of this week, the stock market plunged in response to a report from Citrini Research, which predicted that advancements in artificial intelligence could push the US unemployment rate into double digits by 2028, causing panic among investors. Just a few days ago, Blue Owl Capital Inc. blocked investors from redeeming funds from one of its private credit funds, heightening fears about the loans issued by direct lenders, especially to software companies.
UBS strategists wrote: “The most serious risk is that a shock to a specific industry triggers a chain of defaults. The technology sector is particularly vulnerable to shocks from the application of artificial intelligence or rapid contraction.”
They added: “It is reported that the default rate of private credit is between 3% and 5%, and signs of stress such as interest payments in kind are approaching the highest level since the post-pandemic period.”
Strategists also believe that the default risk of leveraged loans and high-yield bonds is higher. They predict that in the worst-case scenario, the interest rates will reach as high as 6% and 10% respectively. This is higher than the 4% and 8% previously predicted in the report.
Activist investor Boaz Weinstein has ramped up his warnings about private credit, saying the turmoil surrounding Blue Owl Capital’s funds has exposed deeper cracks in the $1.8 trillion private credit industry.
“All you need is one snowball to start rolling down the hill, and it has already started. Blue Owl is right at the center of this snowball,” the founder of Saba Capital Management said at the iConnections Global Alternative Investment Conference in Miami Beach, Florida on Tuesday. “I think we are in the early stages of the snowball starting to fall off.”
This is the latest attack by Weinstein on the private credit industry. Previously, Blue Owl restricted withdrawals from one of its funds, raising concerns about excessive spending on artificial intelligence and lending standards, and the private credit industry is thus suffering a heavy blow.
Saba Capital and Cox Capital Partners jointly announced a cash tender offer to acquire shares in three funds managed by Blue Owl Capital at a price significantly lower than their stated value. Previously, the alternative investment firm had restricted redemptions in one of the funds and begun selling loans to raise funds for investors.
The issue price is expected to be 20% to 35% lower than the net asset value, aiming to provide a liquidity solution for retail investors who wish to exit their positions, as these positions have been difficult to redeem amid the redemption wave across the entire industry.
In a group discussion, Weinstein warned that the market was out of alignment, with some credit assets currently trading at historically high levels, while the related stocks and fund structures were significantly discounted. He also said that he was planning to launch a fund to take advantage of the expected investment opportunities, especially in the Blue Owl fund incident and other similar semi-liquid products facing redemption pressure.
