Aaron Brown: What we still don't know about private credit is troubling

What’s going on in the $3 trillion private credit sector? To understand, let’s start with a sampling of the recent news that’s put investors on edge:

•In February, Blue Owl Capital Inc. gated withdrawals from a retail credit vehicle, meaning investors who wanted their money back were told to wait. Then, it was forced to defend a sale of some loans after Bloomberg News reported that one of the buyers was insurance company Kuvare, whose asset-management arm Blue Owl acquired last year.

•Around the same time, a business development company managed by Apollo Global Management Inc. cut its payout and marked down assets.

•Morgan Stanley’s North Haven Private Income Fund received redemption requests totaling nearly 11% of its outstanding shares; it honored less than half of them.

•JPMorgan Chase & Co. marked down the value of some private credit loans.

These are not isolated incidents. They are the emerging pattern of an asset class entering its first serious credit cycle. That’s to be expected, but in an ominous echo of past financial crises, no one is sure just how much banks’ lending exposure to private credit funds could end up costing the financial system and economy in a shake-up. Estimates vary markedly because there’s no systematic or centralized reporting, no consensus definition of “private credit,” and no way to trace various indirect exposures.

Private credit emerged during the leveraged buyout boom of the 1980s and accelerated after the global financial crisis, when regulators forced commercial banks to pull back from riskier lending. Non-bank financial institutions — including Ares Management Corp. and Apollo Global Management Inc. — rapidly scaled their direct lending platforms, offering middle-market companies flexible loans.

By the early 2020s, the asset class had grown into a multi-trillion-dollar market, attracting institutional investors drawn by floating-rate returns and low historical default rates. More recently, private credit has expanded into more complex strategies including asset-backed finance and infrastructure debt, while opening up to retail and high-net-worth investors.

Now the industry’s furious growth and lending practices are under increasing scrutiny.

Analysts estimate that somewhere between 15% and 25% of many private credit portfolios are tied to software companies facing existential pressure from generative artificial intelligence. These are exactly the kind of highly leveraged firms that took on floating-rate private loans at the top of the market. They now face rising debt-service costs and shrinking business prospects simultaneously. AI disruptions to software firms may drive COVID-level default rates of 8% in direct lending, Morgan Stanley estimates.

The question that should worry policymakers — and is clearly worrying them, based on commentary from the Federal Reserve, the International Monetary Fund and the Bank of England — is whether private credit stress stays contained or spreads.

The answer depends heavily on how tangled the market has become with the conventional banking system — something that’s hard to nail down.

Estimates for U.S. banks range from just under $100 billion from the Federal Reserve to nearly $300 billion from Moody’s. Once unutilized commitments are included, I wouldn’t rule out a number as high as $1 trillion globally today. The IMF estimates that U.S. and European banks now carry $4.5 trillion in exposure to non-bank financial institutions, including private credit funds.

The mechanism for contagion isn’t complicated: Banks that have lent to private credit vehicles take losses if the vehicles deteriorate. Those losses tighten bank lending standards broadly, which ripples through to every business and consumer that depends on credit.

It is not the same as 2008 — private credit is smaller than the mortgage market was, and the leverage employed is generally less extreme. So far, there is no hint of widespread fraud in private credit as there was in mortgage lending in the 2000s.

But if you’re old enough, you’ll remember May 2007, when then-Fed Chair Ben Bernanke said, “We do not expect significant spillovers from the subprime market to the rest of the economy or to the financial system.” Moreover, in May 2007, as in March 2026, credit spreads on high-yield debt in general were near historic lows. So the fact that credit problems seem confined to private credit and a few other relatively small sectors is not a reason for complacency.

Anyway, in 2026, the IMF has explicitly warned that the risks from non-bank financial institutions, if they materialize, may spill over into banks. Jeffrey Gundlach of DoubleLine Capital has been blunter, calling private credit the top candidate to start the next financial crisis.

All this may be premature. Not all private credit funds are stressed, and there has not yet been an unusual number of missed payments to private credit lenders. Investors in many funds are getting less cash than they had hoped for and finding it more difficult to redeem or sell holdings, but this was part of the deal investors understood, or should have understood. The type of middle-market companies that relied on private credit are finding capital harder to come by. These kinds of things are unlikely to cause downstream financial problems.

If things do get worse, there are two likely paths for contagion. One is that private-lending losses become so severe that the credit risk of the loans ends up directly or indirectly on bank balance sheets, eroding capital and risking bank runs. Even if no banks fail as a result, credit could dry up throughout the economy, pushing it into recession.

The other path is if exposure to private credit pops up in unexpected places: 401(k)s, mutual funds and retail portfolios of unsuspecting retail investors; and pension funds, endowments and insurance companies that did not clearly disclose the exposures. Even if the total amounts are not large, fear of additional hidden exposures could threaten confidence in large swaths of the financial system.

So far, we’ve only had a few mild foreshocks of the kind that presage major earthquakes only about 5% of the time. There’s no credit crisis even among mid-market private credit borrowers, only some financial strain in some sectors of that market. Of course, every mighty oak was once a tiny acorn.

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This column reflects the personal views of the author and does not necessarily reflect the opinion of the editorial board or Bloomberg LP and its owners.

Aaron Brown is a former head of financial market research at AQR Capital Management. He is also an active crypto investor, and has venture capital investments and advisory ties with crypto firms.