Liquidity returning to the banking system, U.S. private credit giants are under pressure for their valuation.

After the epidemic, the bank-led liquidity debt market was almost closed to certain types of borrowers for a period of time. Now, these markets are becoming active again. With private credit no longer being the only choice for corporate financing, Wall Street's direct lending competitors - private credit institutions - have seen their pricing power decline and fewer projects are available for funding. Investors have taken note of this and have expressed their judgment by selling off publicly traded funds holding loan portfolios. As market sentiment shifts, the giants of the private credit boom are gradually falling out of favor. Over the past three months, the average stock prices of private equity giants Apollo Global Management Inc (APO.US), Blackstone (BX.US), and KKR (KKR.US) have dropped by over 14%, while the S&P 500 index has risen by nearly 10% over the same period. In addition to these private credit giants, the recent performance of some publicly traded Business Development Companies (BDCs) - important vehicles for private credit - reflects market anxiety. BDCs specialize in collecting private credit resources for various small and medium-sized enterprises that often struggle to raise funds through traditional capital markets. Concerns about credit quality have been escalating as automotive parts supplier First Brands Group and subprime auto lender Tricolor Holdings have collapsed, and two banks have suffered losses due to fraudulent loans. The stock prices of BDCs have started trading at a discount to their net asset value. For large institutional investors considering whether to support the next closed-end credit fund, the fact that similar risky assets are trading at a discount in the public market will at least raise some doubts. Therefore, the latest financial reports issued by many BDCs this week, including Blue Owl Technology Finance (OTF.US), Main Street Capital (MAIN.US), FS KKR Capital (FSK.US), and BlackStone Secured Lending Fund (BXSL.US), will allow investors to scrutinize potential credit risks in the economy and the stock market more clearly. John Cole Scott, President of CEF Advisors, stated, "The latest financial reports from BDCs essentially serve as real-time stress tests for private credit. Compared to banks, BDC financial reports can provide more timely credit data - including loan delinquencies, fair value measurements, originator behavior, and cost of leverage." Default rates are low, but pressure is increasing By most indicators, the issues currently facing credit institutions are more about profit squeezing than complete collapse. Ratings agency Fitch's data shows that as of June, only 1.3% of BDCs hold loans that have stopped paying interest, which is still relatively low by historical standards. Borrowers are still able to pay their bills - on average, their profits are about twice their interest expenses. According to Evercore estimates, this provides enough cushion for companies to avoid cash flow strain even in the case of a 20% decline in profits. BDCs typically focus on medium-market companies that have difficulty accessing loans from traditional banks due to regulatory restrictions (many are supported by private equity). Although BDCs are not subject to such regulatory constraints, all of their loan portfolios must be publicly disclosed, leading to higher-risk financing often being found in traditional private funds with higher leverage and weaker creditor protections. Initially, the borrowing limit for BDCs was only their equity capital, which was increased to twice their equity capital in 2018, mainly through credit lines and bond financing. As expected, actual default rates for listed BDCs are relatively low. As of September, there have been a total of 581 bankruptcy cases in the United States, within the normal range since 2010. An index created by law firm Proskauer to track 739 private credit loans totaling over $140 billion shows that the default rate in the second quarter dropped to 1.8%, down about 1 percentage point from the beginning of the year. However, signs of pressure are still visible. For example, Payment In Kind (PIK) structures involve accruing interest into the principal rather than paying cash, which can temporarily cushion the performance of the lending party while providing borrowers with temporary relief. Raymond James data shows that as of June, PIK payments accounted for nearly 8% of listed BDC investment income, up from 6% two years ago. In the broader private credit sector, Lincoln International reports that PIK income as a percentage of total income rose to around 11% in June. When factoring in distressed debt exchanges and other informal restructurings, the industry's "true disposal rate" exceeds 4%, more than twice the formal default rate. Competition intensifies, the era of private credit monopoly is ending A surplus of capital is forcing lenders to increase competition. An active public market means borrowers do not have to pay a premium in the private market. The spread between junk bonds and US Treasury benchmark yields has narrowed to 2.9 percentage points - about half the long-term average, with yields remaining around 6.7%. PitchBook LCD data shows that overall yields for corporate loans arranged by banks and sold to syndicated investors reach 7.4%, while Houlihan Lokey data shows that private credit institutions can still achieve yields of around 9.5%. Companies naturally choose cheaper financing options. From June to September, syndicated loan volume reached its third highest level in history, second only to the first quarter of this year, with about four-fifths of this going towards refinancing existing debt, saving borrowers over $2 billion in interest expenses annually. However, demand from buyers remains unsatisfied. PitchBook LCD estimates that institutional investors, represented by Collateralized Loan Obligations (CLOs) - who buy, package, and resell these debts - continue to pour in substantial funds. Since 2022, inflows into CLOs and loan funds have exceeded total market debt supply by over $40.5 billion, with excess funds pouring in this quarter alone reaching $41 billion. This feverish demand is changing the market dynamics. As of early September, approximately $25 billion in loans have shifted from private to widespread syndicated lending, with the migration rate increasing by about a quarter compared to last year. At the same time, loans directly used for acquisitions and mergers have decreased by 24% year-on-year in the first eight months of this year - both in terms of number of transactions and scale - while overall merger and acquisition transaction volume has increased by 25% during the same period. With new loan rates falling and repayment rates exceeding new lending rates, BDCs' profits and dividends distributed from these profits are inevitably being squeezed. Multiple BDCs managed by firms such as Blackstone, Oaktree Capital Management, and OFS Capital have already cut dividends by over 9% this year due to falling benchmark rates and weak income. The market clearly anticipates that this trend will continue. As of October 31st, the overall yield of the Cliffwater BDC index is 10.8%, but its trading price is at an 8.1% discount to net asset value. In other words, each dollar of assets is only worth 91.9 cents, resulting in a yield of 9.9%, significantly lower than recent highs. Overall, the growth rate of credit funds is outpacing the availability of suitable investment opportunities. The prices of publicly traded BDCs already reflect expectations of slowing profits. Private funds will also face the same pressures. In a market that once prided itself on "greed," cautious restraint may become a new virtue.