Instability in the private credit market has expanded from Business Development Companies (BDCs) to the broader credit ecosystem. While the CEO of JPMorgan believes it does not yet constitute a systemic risk, recent reports from Barclays and UBS highlight a previously overlooked vulnerability: the deep interconnection between private credit and the Collateralized Loan Obligation (CLO) market.
As BDCs face substantial redemption pressures, private credit valuations may shift from model-based pricing to market-based marking. Investors should be wary of net asset value impacts stemming from declines in underlying assets, particularly software and SaaS loans.
Concurrently, spreads on unsecured BDC bonds have widened significantly, yet pricing in the private credit CLO market has not fully reflected this reality. Barclays notes that BDCs are highly comparable to Single-A rated CLOs. With software loan default rates rising, the CLO market is increasingly likely to become the next focal point of risk.
UBS warns that an increase in private credit defaults will lead to a sharp contraction in leveraged loan and CLO issuance. Given the significant overlap of investors between public and private credit markets, liquidity stress could rapidly spread to the broader public credit market.
The crisis originated with a surge in BDC redemptions and a valuation transparency crisis. Over the past two months, assets linked to private credit have faced selling pressure. Two private credit funds under Blue Owl saw redemption requests reach 41% and 22% respectively, driving several listed private credit/BDC securities to record lows.
The CEO of JPMorgan cautioned that private credit generally lacks transparency and rigorous loan valuation marking, leading to higher actual losses than would occur under normal conditions. He also warned that insurance regulators will eventually demand stricter ratings or write-downs, which could lead to retail investor litigation.
Data from Pimco clearly shows that publicly traded BDCs are trading at a significant discount to their Net Asset Value (NAV), indicating a growing valuation gap between public and private markets. Nevertheless, the CEO also stated that private credit "may not" pose a systemic risk due to its relatively limited size within the overall credit market—a view consistent with an earlier Goldman Sachs report.
However, a Barclays research report suggests this assessment may overlook the deep linkages between private credit and derivative markets like CLOs. The bank's credit analyst noted that, unlike the significant sell-off in Broadly Syndicated Loan (BSL) CLO assets, private credit CLOs have not experienced a similar downturn. Year-to-date, private credit CLO prices have seen minimal movement, while US BSL CLOs above par have plummeted from 59% to 22%. Barclays argues that current BDC pricing is severely disconnected from the reality in the CLO market.
Asset coverage tests are a key constraint for BDCs. Under the 1940 Act, BDCs must maintain assets covering at least 150% of their debt. Barclays calculates that the median BDC asset value would need to fall by 21% to breach this threshold—a point most analogous to the Single-A tranche in a standard BSL CLO structure. Therefore, Single-A CLOs serve as the best benchmark for assessing the relative value of BDC unsecured bonds.
Quantifying the impact of software loan sell-offs, Barclays estimates that US BSL CLOs have a direct software exposure of 11-13%. For every 1-point drop in software loan prices, Single-A CLO spreads would widen by 4 basis points. BDCs, with a higher software exposure of around 20%, would see their unsecured bond spreads widen by 4.8 basis points under the same shock. Recent market performance shows Single-A CLO spreads have widened by about 20 basis points, whereas BDC unsecured bond spreads have widened by nearly 75 basis points since January. Barclays' model suggests this implies BDC bonds have underperformed Single-A CLOs by approximately 50 basis points. As investors search for the next credit weakness, attention will inevitably turn to the CLO market, which has so far been largely unaffected.
UBS outlines the transmission channels of private credit stress to CLOs and public markets. The bank expects leveraged loan issuance to contract by about 20% to $360 billion in 2026, with CLO issuance falling from an estimated $208 billion in 2025 to around $150 billion. In a tail-risk scenario, issuance could drop by 50-75%. Regarding credit quality, UBS analysis indicates that 11-12% of US and European leveraged loan portfolios are in high AI-disruption risk sectors with low ratings, with about 8% at risk of being downgraded to CCC within two years. This would increase CCC concentrations in CLO portfolios, which are already nearing their 7.5% limits.
UBS identifies four main transmission channels to public credit markets: investor overlap (e.g., insurers, foreign investors); BDC holdings of syndicated loans (averaging 10% exposure); high valuation correlation between private credit and global leveraged loans; and historical correlation in issuance patterns between US/European leveraged loans and US high-yield bonds.
Concerning valuation evolution, UBS notes that BDCs represent about one-third of private credit investment assets. If redemption pressure impacts BDC liquidity, valuations will shift from model-based to market-based marking. Historical price levels for B3/B- rated loans during past crises provide reference points for this potential repricing.
In summary, the analytical chain from Barclays and UBS is clear. First, AI disruption risks in software/SaaS companies erode BDC asset quality, widening spreads and increasing redemption pressure. Second, deep structural linkages exist between BDCs and CLOs, but private credit CLO pricing does not yet reflect this stress—a gap that will eventually close. Third, once CLO pricing adjusts, it will trigger a chain reaction including CCC downgrades, overcollateralization test failures, and reduced CLO issuance, transmitting stress to the broader public credit market via investor overlap and valuation correlations.
As Barclays points out, investors seeking the next credit market weakness will inevitably focus on CLOs—a market that has so far been largely insulated from the BDC downturn. UBS further warns that if AI disruption in the software sector deepens alongside a broader economic slowdown, the private credit crisis will not only worsen but also use CLOs as a conduit to spread throughout the public credit market.
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