Private credit funds face five-year default highs in Q2

Private credit defaults at four listed direct-lending funds reached five-year highs in the second quarter, testing managers’ portfolio claims.

The latest quarterly updates from funds overseen by Ares Management, Blackstone, Blue Owl Capital and Golub Capital showed weaker loan health and lower investor returns. The vehicles trade publicly, which requires regular disclosures on their loan books and gives investors a clearer view than in many private funds.

Four funds show strain

Defaulted or nonaccruing loans across the four funds touched their highest levels since at least 2021, according to the companies’ quarterly reports cited in the source material. That puts current stress above the levels reached in 2023, when Federal Reserve rate increases lifted borrowing costs for corporate issuers.

Blue Owl Capital Corp. reported defaulted loans equal to 2.8% of its fund in the second quarter, its highest level in at least five years. Nonperforming loans at Ares Capital Corp., Golub Capital BDC and Blackstone Secured Lending Fund also reached five-year highs in the same period.

Managers contest the alarm

Blue Owl, Blackstone and KKR have said concern about private credit is overstated, pointing to portfolio performance rather than recent headlines. Blue Owl co-CEO Marc Lipschultz told analysts on the firm’s quarterly call: "Across our direct lending strategy, credit health remains strong."

David Golub, co-chief executive of Golub Capital, offered a more measured view of the cycle. "Some in the press have been saying ‘Oh no, the sky is falling,’ and some of my peers at other firms have been saying ‘That’s nonsense, there’s no problem,’" Golub said. "Neither of those is accurate. We are clearly in a credit cycle. It’s not a particularly bad one, but there will be winners and losers."

Health care loans lead losses

Private credit funds lend client money directly to indebted companies, usually at higher interest rates than borrowers would pay in public bond markets. The direct-lending model drew investors during a period when those yields compared favorably with many traded credit products.

The weaker loans identified so far are concentrated mainly in health care businesses, including dental-service provider Affordable Care, and companies exposed to higher oil prices, including plastic-film maker Loparex. Analysts and fund managers cited in the source material are watching whether stress spreads to software borrowers, which account for 20% or more of loans in many private-credit portfolios.

Investor concern has also followed several high-profile defaults tied to alleged fraud and to software companies exposed to disruption from artificial intelligence. Some individual investors who bought private-credit funds have asked to withdraw money, adding a liquidity test to the credit test.

Three paths for borrowers

If interest rates decline and economic activity holds without a renewed inflation pickup, losses could ease as borrowers refinance or preserve cash flow. For the macro picture, that would keep private credit from becoming a broader financial drag; for Blue Owl, it could help cap the 2.8% default ratio; for the industry, it would support the case that current stress is cyclical.

If rates instead remain elevated, debt-service costs would stay under pressure for companies that borrowed heavily in direct-lending markets. That path would leave Blue Owl and peers defending loan marks and income distributions, while the wider sector could face more redemption requests from individual investors.

If software weakness broadens, the issue would shift from a rate cycle to underwriting and sector selection. The macro effect would be narrower than a systemwide credit squeeze, but funds with software exposures of 20% or more would face greater dispersion in returns, and direct lenders would likely tighten terms for technology borrowers.

The main open question is whether nonperforming loans remain concentrated in health care and oil-linked businesses or move into larger software books. The next quarterly filings, default classifications and investor withdrawal data will show whether the cycle stays contained.