"Wall Street private credit empire faces its first major test: intensifying wave of redemptions, can it withstand this time?"

The Wall Street's profitable private credit empire is now facing its first truly meaningful stress test since its establishment. Recently, institutions like BlackRock, Inc. (BLK.US) and Morgan Stanley (MS.US) have set up funds for high net-worth individuals with redemption restrictions, prompting small investors to continue to withdraw from this $235 billion market. These fund structures were designed to withstand long-term market storms, but their ability to safely pass this test depends on their ability to curb rising default rates and maintain investor confidence in the face of ongoing collapse. The core issue lies in Business Development Companies (BDCs) - which serve as the core engine of expansion for private credit into the retail market. In the past, entering into such relatively lightly regulated, large-scale private investments was exclusively the domain of institutional investors such as insurance and pension funds. However, non-publicly traded BDCs provided a convenient pathway for the masses of ordinary high net-worth individuals to participate in the non-bank loan market with bilateral negotiations and high yields. Unlike publicly traded BDCs that do not frequently raise equity and subsequently allow shares to be traded on the open market, non-publicly traded BDCs provide a continuous issuance of shares to investors, providing an entry channel. Investors can choose to exit in regular tender offers, with share prices determined by the fund based on their net asset value. This business has proven to be extremely lucrative. Blackstone's massive BCRED fund, with $83 billion in assets under management, topped the industry last year with $1.2 billion in fee income. Given that this fund accounts for more than a third of non-public BDCs' net assets, this means that the total annual fee income for the entire industry exceeds $3 billion. These large funds have become a key pillar of the entire private credit system, helping institutions like Blackstone gradually squeeze traditional banks out of the market. According to research firm RA Stanger, publicly registered related funds hold approximately $235 billion in loan assets, and when including private funds, the total size will exceed $300 billion. But now, this "money-making machine" is beginning to malfunction. Starting with Asian retail accounts, high net-worth investors are continuing to withdraw funds. The industry generally has redemption limits and regular tender offers have a hard maximum limit, with the usual restriction being no more than 5% of the asset size per quarter. According to RA Stanger data, ignoring new cash inflows, industry-wide redemptions in 2025 continued to rise, reaching a peak of 4.6% of industry net assets in the fourth quarter, a trend that is expected to continue to accelerate in 2026. BlackRock, Inc. and Morgan Stanley were the first companies to implement their promised 5% redemption limits, followed by Apollo Global Management Inc (APO.US) and Ares Management (ARES.US). Industry experts expect all management institutions to follow suit, although Blackstone's BCRED fund is still fully meeting all redemption requests to date. Although this does not mean that funds will completely withdraw: BlackRock, Inc.'s HPS Corporate Lending fund had net inflows in the first quarter, while Apollo's related products were mostly stable. However, the biggest question in the market is whether high net-worth investors will continue to invest more, or if funds will continue to be redeemed. There are reassuring precedents in the market. Before the private credit boom, non-publicly traded CareTrust REIT Inc (REIT) was a popular choice for retail investors. Similar to BDCs, these products also have "semi-liquidity", providing limited regular redemption channels, with Blackstone's BREIT product being a representative among them. The interest rate hike cycle in 2022 triggered widespread pessimism about real estate values, causing related products to face massive redemptions, eventually leading to redemption restrictions. The good news is that most funds eventually weathered the crisis; the bad news is that total industry fund inflows plunged significantly, with non-public REITs' equity size shrinking by nearly a quarter during this period. Private credit has certain inherent advantages. The related loans all have fixed amortization plans, meaning that these loans will gradually be repaid over time. In the absence of defaults, in the investment portfolios of direct lending institutions, about 15%-20% of the debt is repaid annually based on value. Although most loans have terms of 5 to 7 years, many growth borrowers will turn to the lower-cost syndicated loan market for refinancing, allowing for early repayments. In most cases, this kind of regular cash flow can cover most of the redemption requirements of BDCs even if it does not cover the entire amount. Of course, this kind of repayment flow can also dry up. Analysts and banking professionals said that during the 2008 financial crisis, the annual repayment ratio dropped to around 12%. Should such a situation occur, funds can use the cash and liquid assets reserved for emergencies. Moody's Corporation estimates that most funds hold high-liquidity assets that can cover at least three-quarters of cash outflows. If this is still insufficient, institutions can use more leverage, as regulatory limits allow them to borrow up to twice their equity value. As it stands, institutions still have sufficient room to maneuver: data from Moody's Corporation shows that the average debt size of non-public BDCs is only equivalent to 80% of the investors' capital. All signs indicate that even in the face of long-term fund outflows, BDCs can still weather the storm under the premise of implementing the 5% redemption limit. But the core risk lies in the fact that if funds continue to return to investors, institutions will be unable to reinvest them to generate returns that can attract new capital. If investors continue to wait on the side-lines, this semi-liquidity design will gradually become a heavy burden and may eventually lead to forced liquidation. In the long run, there are many factors that could make investors hesitant. More and more borrowers are overdue or in breach of contract terms. Data from Fitch Ratings tracking the credit conditions of private enterprises shows that the default rate in February was 5.4%, although it was slightly lower than January, it is still higher than in recent years. If conflicts in the Middle East cause energy shocks or industry shocks intensify due to artificial intelligence (AI), credit losses could further expand. RA Stanger researchers estimate that on average, 25% of BDC funds are invested in companies vulnerable to AI-related risks, with different funds having widely varying exposures ranging from 9% to 41%. The pricing on the public market already indicates unavoidable losses: according to PitchBook LCD data, since the beginning of the year, the prices of widely traded software company loans have dropped from 95% of face value to 87%. Defaulting bad debts will erode fund equity, not only further tightening leverage restrictions but also leading to the devaluation of the assets used as loan collateral by BDCs. If a fund with an initial equity leverage ratio of 80% experiences a 20% loss in its investment portfolio, its leverage ratio will soar to over 120%. At that time, rating agencies may tighten ratings, making it much harder for institutions to refinance. Fund managers argue that they have long foreseen and prepared for AI-related risks. At the same time, private credit, which offers higher returns compared to similar products with greater liquidity, may still attract investors back. However, most industry insiders expect a shake-up in the industry, with products that have excessive exposure to the software industry and high leverage facing an existential crisis. Historical experience suggests that the industry is on the brink of a cold winter.