When It Comes to Private Credit, Investors Are Not Getting Paid Enough for Downgrade and Default Risk

On the March 2 episode of The Morning Filter_, _David Sekeraand Susan Dziubinski discuss what effect Blue Owl’s OWL private credit problem has had on the markets and why Sekera thinks investors should steer clear of private credit. Here is an excerpt from the show.

How Blue Owl Reveals Worrying Ripple Effects of Private Credit Market Risks

**Susan Dziubinski: **Dave, private credit has also been in the news recently after Blue Owl OWL halted redemptions at a private credit fund aimed at retail investors. So let’s talk about what’s been going on in the private credit market that led Blue Owl to do that, and then what the ripple effects have been.

**Sekera: **Sure. But even before we get into that, just some background for people that don’t know exactly what the private credit market is. It’s certainly been the fastest-growing asset class in the markets over the past 15 years. Now, depending on how you want to run the numbers, it looks to us like it’s somewhere around $1.7 trillion in assets at this point. Now, a huge amount of that growth in the private credit market has been concentrated in middle market companies. Typically, what we’ve seen is that PE sponsors, private equity sponsors, when they’ve been buying out these companies, have been leveraging them up. And in many cases, at very high debt to EBITDA multiples. But these deals are often too small for the high yield and levered loan market, which is why we’ve seen this go into the private credit market.

But as you see, and this always happens in the markets, when something is doing too well for too long, it brings in too much new money. And when you have too much new money chasing too few deals, I think a lot of these deals had attributes that were just unattractive, they were overleveraged, had weak covenants, deals that just probably shouldn’t have gotten done, but people had money that they needed to put to work so they were doing it anyway. There is a really good article on Morningstar.com. The title is “Why AI Worries About Software Are Hitting Private Credit.” That, to me, is a really a great explainer article that has a lot more of the background information.

Why AI Worries About Software Are Hitting Private Credit

So what’s happening now? Well, credit quality in these deals has certainly been weakening. DBRS Morningstar has been warning really since early 2025, that they’ve seen the credit quality in a lot of these companies getting weaker and weaker. They’ve noted they’ve seen an increase in waiver requests and increase in companies breaking their covenants. They’ve noted that they’ve had a lot more downgrades than upgrades. A lot of these deals were getting weak enough that it required new capital injections from the private equity sponsors to keep these companies in business. And even with that the number of defaults have been increasing well over the past year. And now what we’re starting to see is that it’s becoming a large enough problem of credit weakening, enough companies missing or defaulting, that it’s really starting to impact the pricing of that part of the market overall.

Now, Blue Owl specifically, a lot of machinations have been going on there between the asset manager and a number of their different funds. But, as you noted, one of the private funds did close the gate, meaning that they halted redemptions within those funds. So at this point, they’re just going to return the money to those shareholders when, and if they can, when the positions are either sold or repaid or have to go through some kind of bankruptcy process. In my mind, I think this just exemplifies to investors the risk of using what is an illiquid asset in a vehicle that tries to provide liquidity.

Now, if you remember in our quarterly outlooks and our annual outlooks, it’s been a while now that we’ve recommended investors to steer clear of corporate credit risk, whether that’s been private credit market, levered loan market, high-yield market, even investment-grade market. When you look at where credit spreads are, we just didn’t think investors were getting paid enough for downgrade and default risk. In my mind, I still think there’s a lot more downside risk in private credit that could still yet to come. When I look at these type of transactions, the way that they’re structured, I think loss given default will be a lot lower or actually it’ll be a lot worse. You’ll get lower recoveries than you would in traditional levered loans and high yields. And I think as that comes through, you’ll see a ripple effect in the market, specifically in the corporate bond market. But what’s going to happen is you’re going to have less liquidity in that market, you’ll have less liquidity in the high-yield and levered loan market. And at some point, that will flow through to other asset classes, meaning you’ll just have lower valuations here, which means you’ll bring valuations down across all of the asset classes.

So, really, it just depends on how severe the downturn is here. It’s going to depend on if the economy weakens from here, how much the economy weakens. If we were to have a recession, if we have any kind of recession, I think a lot of these middle market companies are going to be in big trouble. And we would see a big spike in default rates there. So, depending on how severe that is, it could negatively impact the economy overall and the markets in general. So, really, a long-winded answer of saying, I think there’s a lot more risk here yet to come. I think there’s still more downside in the pricing in private credit yet to come. But to some degree, whether or not it’s going to impact markets overall, it’s probably going to depend on what happens with the economy over the next couple of quarters.

What Is Blue Owl?

The firm’s oversight of some of its private credit funds has drawn scrutiny and highlighted concerns for individual investors.

Blue Owl Offers a Harsh Lesson for Semiliquid Fund Investors

Analyzing the saga of this private credit BDC.

Blue Owl Disclosure Drives Down Share Prices of Alternative Asset Managers

This is a warning sign for the industry and the rule makers about the downside of illiquid funds.

Why Investors Should Steer Clear of Private Credit in the Wake of Blue Owl’s Saga

**Dziubinski: **So then, Dave, what should investors make of Blue Owl specifically? The stock pulled back after this news, of course, and so did the stocks of some of the other asset managers. And then, more broadly, doesn’t, reading between the lines, or not between the lines, you pretty much said that investing in private credit today is probably not the best idea. Is that fair to say?

**Sekera: **Well, that’s certainly my opinion. And when you think about an asset management firm and how they make money, I mean, they make money by charging a fee as a percentage of assets under management. And in this case, for Blue Owl, it’s going to be harder and harder to raise new assets under management. And in fact, if private credit sells off, then you’ll have declining assets under management, which means that you should expect then to see lower revenue going forth.

So personally, I’d still steer clear of putting any new money into corporate credit. I still expect that corporate credit spreads are going to widen out from here. And as you have the widening in private credit, that’s going to then lead to wider spreads in the levered loans, which then leads to wider spreads in high yield, which then leads to wider spreads in investment grades. I still prefer keeping your fixed-income asset allocation, specifically in US Treasuries. If you want to try and get some spread there, maybe move into some of the mortgage-backed securities, maybe some of the structured finance. But again, I’d still steer clear of anything to do with the corporate bond markets until you really get more of a wash out there.

Subscribe to The Morning Filter on Apple Podcasts_, or wherever you get your podcasts, and keep up with the latest research from hosts Susan Dziubinski and David Sekera on Morningstar.com._

		5 Stocks to Buy Before They’re Not Undervalued Anymore

		Plus, whether Nvidia is a buy after earnings.
	





			43m 37s
		 Mar 2, 2026

Watch