After a series of private credit defaults in the United States, PIMCO warns that the industry is facing a "comprehensive default cycle."

According to analysis from Pacific Investment Management Company (PIMCO) on the risks of private credit, after the 2008 financial crisis, direct lending institutions set a record for financing amounts, leading to a relaxation of underwriting standards and now facing stress tests. Analysts Lotfi Karoui and Gabriel Cazaubieilh stated in a report to clients on Friday, "Like all mature leveraged financing sectors, direct lending will ultimately face a full default cycle - testing its ability to withstand industry-specific shocks and macroeconomic shocks." In recent months, concerns about defaults have been heightened by high-profile corporate bankruptcies, as well as worries about the sensitivity of direct lending funds to software companies at risk of disruption by artificial intelligence, increasing worries in private credit. This unease has primarily manifested in investors of Business Development Companies (BDCs), which are closed-end private debt instruments aimed at retail clients. With many concerned BDC investors seeking redemptions, alternative investment firms like BlackRock and Blue Owl have restricted redemptions. These investors are realizing that they may not always be able to withdraw funds from so-called semi-liquid funds. While these funds offer quarterly redemptions, they can restrict withdrawals when a certain threshold is reached. They wrote, "Although the risk of a true 'bank run' in these investment vehicles is generally low given clear contractual redemption limits and fund manager control over fund flows, semi-liquidity does not mean full liquidity. Investors still need to assess their own liquidity needs and tolerance for restricted capital access." They noted that an over-reliance on software assets in direct lending portfolios could limit their performance relative to public stocks and other private credit products. Additionally, PIMCO analysts pointed out that direct lending funds do not offer compensation for long-term lock-up of investor funds. PIMCO was one of the earliest critics of private credit, which has now grown into a $1.8 trillion industry. As the financing levels of direct lending strategies soar, the asset management company takes a contrarian approach, seeking out issues emerging from companies supported by private credit. The 55-year-old company, originally a bond giant, now manages around $2.3 trillion in assets. However, PIMCO analysts noted that these concerns should not affect the overall outlook for private credit, which includes more than just direct lending and BDCs. PIMCO analysts highlighted some private credit "channels" they see value in, including asset-based lending, which they say can offer an "investment-grade" level of risk. Last year, PIMCO raised over $7 billion for an asset-based financing strategy, including its first funds designed specifically for insurance companies and wealthy individuals.