Inflated net asset values and redemption restrictions! Is the current "PE private credit crisis" a new round of "subprime"?

A wave of panic over the private credit market is spreading. Fourier Asset Management Chief Investment Officer Orlando Gemes issued a stern warning: "The danger signals we see today in private credit are strikingly similar to those in 2007."

He specifically pointed out the deterioration of lender protection clauses and complex liquidity terms that "mask the mismatch between the assets investors believe they hold and the assets they are actually able to exit."

According to Chasing Wind Trading Desk, on February 23, Deutsche Bank released the report "Private credit: Smoke, yes, but how much fire?". The report indicated that the price-to-net asset value ratio of S&P BDC Index constituent funds has fallen to its largest discount since the shock of the Covid pandemic, and events such as Blue Owl restricting redemptions and Breitling’s valuation being slashed have further fueled the fire.

Despite the recent decline in relevant stock prices, Deutsche Bank believes that the conditions for large-scale market contagion are not currently present. Investors now need to closely monitor credit spreads, corporate profits, Treasury market stress, and regulatory changes—four main trigger indicators—while recognizing that the more than $3 trillion in "dry powder" (uninvested funds) reserves may serve as a key buffer.

BDC Discount Hits Record: Thermometer of Market Panic

Business Development Companies (BDCs) are becoming a weather vane for the private credit crisis. Deutsche Bank data shows that these listed institutions, highly exposed to private credit and the software industry, are trading at the highest discount to net asset value since the Covid pandemic.

Panic intensified further last week. Blue Owl announced redemption restrictions and asset sales on one of its funds. Although this move was meant to boost confidence, some investors used the opportunity to sell off private capital-related targets. Subsequently, the Financial Times reported that Breitling’s private equity owner had halved the value of its investment, which further fueled market panic.

Non-Bank Financial Institutions: Underestimated Systemic Risk

The real concern is the increasing share of non-bank financial intermediaries (NBFIs) in the financial system. Recent research by the New York Fed highlights risks posed to banks by NBFI growth. Key data shows that NBFIs now account for more than 50% of global financial assets, and in the US, the ratio is as high as 60%.

Risk transmission mechanisms deserve vigilance: Since the financial crisis, banks have reduced their direct exposure to the real economy, but through obligations to NBFIs, they are indirectly exposed. Specifically, banks provide senior loans to NBFIs, which then grant junior credit loans to subsequent borrowers. This multi-layered structure could trigger chain reactions if problems arise.

Fed Vice Chairman Bowman pointed out that, prior to the financial crisis, banks issued 60% of mortgage loans. This proportion has almost halved since, with borrowers turning to non-bank lending institutions.

$3 Trillion "Dry Powder": Lifesaver or a Drop in the Ocean?

Deutsche Bank believes there is currently more than $3 trillion in "dry powder" in the private capital market—enough to cope with recent financial issues, as most large private capital loans are issued by large institutions. These institutions are highly diversified, have significant influence, and their investors are unlikely to refuse capital calls.

However, the situation in the middle market is entirely different. Many middle market institutions depend heavily on recently plummeting software investments, and their diversification is lacking, making them the most vulnerable link at present.

Four Key Indicators: The Threshold of Crisis

Deutsche Bank clearly stated that for the negative scenario to materialize and spread contagion to banks, economic and market conditions must deteriorate. Specifically, the following situations, or some combination thereof, need to occur:

1. Sharply rising credit spreads and/or interest rates
2. Significant contraction in corporate profits
3. Worrying pressures in the Treasury market, especially at debt auctions
4. Changes in bank regulation or capital requirements regarding private market exposures

The key conclusion: none of these four indicators currently pose a dangerous threat to the private capital market in terms of their potential to trigger broader market contagion and destruction.

Current Assessment: There’s Smoke but Not Much Fire

Deutsche Bank characterizes the current situation as "heavy smoke, unclear fire," emphasizing not to equate liquidity volatility with a credit meltdown. Investors often mistake unique issues with individual investments for broader market trends—this is a classic "correlation, not causation" misjudgment.

Although AI sell-offs stem from concerns about software companies’ long-term disruption, most software firms are still expected to retain their customers and profits, meaning they should have cash flow to pay creditors in the short term.

More importantly, given the strong performance of the stock and credit markets, healthy corporate profits, a resilient US labor market, and an overall robust economy, the background conditions for a sharp loss of confidence are not present.

For investors, in the short-term, monitor the four indicators listed by Deutsche Bank and whether the "net asset discount" on vehicles like BDCs continues to spread across the market. When the discount turns from sentiment to a hard constraint in the financing chain, that’s when risk begins to transmit from localized areas.

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The above content is from Chasing Wind Trading Desk.

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