- Redemptions reflect sentiment and rebalancing, not deteriorating credit quality
- Limits are a structural safeguard against forced selling in stressed markets
- Current pressures are market-driven, with little sign of distress or impairment
- What matters is selectivity: resilient assets, strong managers, and senior capital
Related Insights
Recent headlines around private credit redemptions have attracted significant attention, but these headlines often conflate liquidity pressure with solvency risk. Treating the forces of liquidity and solvency as equivalent can lead to misunderstandings about the state of private credit. Solvency pertains to borrowers’ ability to cover liabilities with assets and meet loan repayments, while liquidity pressure arises when investors rush to redeem their positions, challenging managers with flow management. While periodic redemptions are intended to be modest and manageable, periods of perceived market stress can see redemption demand elevate even as asset fundamentals remain intact.
To manage liquidity while simultaneously preserving asset value, managers specify details about redemption gates at inception. More than a liquidity management tool, gates can become structural safeguards in the face of elevated redemptions, facilitating orderly exits, preventing unfavourable asset sales, and ultimately protecting value for remaining investors.
Recent episodes illustrate how this dynamic plays out in practice. In private real estate funds, redemption requests rose to c.4x of stated limits (i.e. 5% of NAV) back in 2022. Yet these were largely met approximately three quarters after peak redemption without forced asset sales or asset impairment, underscoring the importance of manager quality in manoeuvring redemption spikes. More recently, in private credit, redemption requests appear to have mostly remained well below such levels and can largely be characterised as market driven rather than performance driven. This distinction is critical. Performance driven redemptions can, at times, trigger forced selling and crystallise losses, whereas market driven redemptions reflect sentiment rather than true deterioration. Manager disclosures support this market-driven assessment. EBITDA growth among private credit-backed businesses is reportedly hovering near a four-year height of c.5.8%. Meanwhile, first-lien loans now account for c.76% of portfolios, highlighting a growing emphasis on downside protection through more senior capital structures. Evidence from secondary markets reinforces this interpretation, with Blue Owl executing loan sales at near-par of 99.7%. This would be inconceivable if underlying assets were genuinely under any performance-related distress.
Even so, critics have often raised concerns about private credit quality by disproportionately citing so-called “shadow” default rates. “Shadow defaults” include payment-in-kind (PIK), covenant amendments, waivers, and maturity extensions, and though these trend higher than “hard” default rates, they have in fact declined from 5.72% earlier in the cycle to 4.49%. Importantly, when interpreting “shadow defaults”, investors should recognise that PIK toggles, covenant resets, and maturity extensions are credit management tools designed to stabilise businesses through temporary cash flow pressures, and do not always equate to outright payment failure. Additionally, managers rarely extend such terms to all borrowers. Smaller or more highly leveraged borrowers are limited in their ability to access such payment flexibility, precisely to circumvent unmonitored default risk (Figure 6). Broadly speaking, with respect to credit quality, non performing (or non-accrual) loans have remained range bound below recessionary levels while recovery rates have trended higher. Interest coverage ratios have also improved since the rate hiking cycle, reflecting a stronger ability to service debt. Across both public and private markets, credit spreads have also not widened to levels seen in past crises, reflecting low systemic risk.
Private credit continues to offer yields above those of public high yield bonds, indicating that investors are still being compensated for illiquidity and complexity. During the 2022 rate hiking cycle, private credit demonstrated relative resilience despite significant volatility in public markets. Contrary to popular belief, valuations have also tended to be more conservative, with marks proving more cautious than realised losses. This reduces the likelihood that quarterly portfolio values overstate reality.
Software exposure, frequently cited as another area of concern, is far from homogeneous. Mission critical software providers, with products that are deeply embedded in organisational processes, tend to exhibit durable demand and slower disruption dynamics, while more peripheral applications are more exposed to competitive pressures. The key issue, therefore, is not how much a private credit portfolio is exposed to software, but rather the kind of software exposure the portfolio contains.
Figure 1: Private real estate fund redemptions in 2022 were fulfilled within three quarters after peaking at c.4x above limits
Source: SEC filings, iCapital, DBS; Note: For illustrative purposes only. Redemptions were from BREIT which offers monthly share redemptions of up to 2% of assets, subject to a quarterly cap of 5%.
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