A wave of panic is spreading through the private credit market. Orlando Gemes, Chief Investment Officer at Fourier Asset Management, issued a stark warning: "The red flags we see today in private credit are strikingly similar to the situation in 2007." He specifically pointed to the deterioration of lender protection covenants and complex liquidity terms that "mask the mismatch between the assets investors believe they hold and what they can actually exit." According to market sources, Deutsche Bank released a report on February 23 titled "Private credit: Smoke, yes, but how much fire?". The report indicated that the price-to-net asset value ratio for funds in the S&P BDC index has fallen to its largest discount since the COVID-19 market shock. Events such as Blue Owl restricting redemptions and the halving of Breitling's valuation have further fueled concerns. Despite recent declines in related stock prices, Deutsche Bank believes the conditions for widespread market contagion are not yet in place. Investors currently need to closely monitor four key trigger indicators: credit spreads, corporate profits, Treasury market pressure, and regulatory changes. They should also recognize that over $3 trillion in "dry powder" (uninvested capital) reserves could serve as a crucial buffer.

Record BDC Discounts: A Barometer for Market Fear Business Development Companies (BDCs) are becoming a bellwether for the private credit crisis. Data from Deutsche Bank shows that these listed entities, which are heavily invested in private credit and the software sector, are trading at their highest discount to net asset value since the COVID-19 pandemic.

Panic intensified last week. Blue Owl announced redemption restrictions and asset sales for one of its funds. While this move was intended to bolster confidence, some investors used it as an opportunity to sell holdings related to private capital. Subsequently, the Financial Times reported that Breitling's private equity owner had slashed the value of its investment by half, further adding fuel to the market's fears.

Non-Bank Financial Institutions: An Underestimated Systemic Risk The real concern lies in the growing share of Non-Bank Financial Intermediaries (NBFIs) within the financial system. Recent research from the New York Fed highlights the risks that NBFI growth poses to banks. Key data shows that NBFIs now account for over 50% of global financial assets, a figure that rises to 60% in the United States. The risk transmission mechanism warrants caution: although banks have reduced their direct exposure to the real economy since the financial crisis, they remain indirectly exposed through their obligations to NBFIs. Specifically, banks provide senior loans to NBFIs, which in turn issue junior credit loans to end borrowers. This multi-layered structure could create a chain reaction if problems emerge. Federal Reserve Vice Chair for Supervision Michelle Bowman noted that before the financial crisis, banks originated 60% of mortgages, but that share has since nearly halved, with borrowers turning to non-bank lenders.

$3 Trillion "Dry Powder": A Lifeline or a Drop in the Bucket? Deutsche Bank argues that the more than $3 trillion in "dry powder" within the private capital markets is sufficient to handle near-term financial issues. This is because the vast majority of large private capital loans are issued by large institutions. These institutions are highly diversified and influential, and their investors are unlikely to refuse capital calls. However, the situation in the middle market is entirely different. Many middle-market firms are heavily reliant on software investments, which have recently seen significant declines, and lack sufficient diversification, making them the most vulnerable segment currently.

Four Indicators: The Tipping Point for a Crisis Deutsche Bank clearly states that for a negative scenario to materialize and trigger contagion to banks, a deterioration in economic and market conditions is necessary. Specifically, some combination of the following would need to occur:

A sharp rise in credit spreads and/or interest rates A material contraction in corporate profits Worrisome stress in the Treasury market, particularly during debt auctions Changes in bank regulations or capital requirements concerning exposure to private markets

The key conclusion is that currently, none of these four indicators have reached levels dangerous for the private capital market, in terms of their potential to cause broader market contagion and disruption.

Current Assessment: Smoke but Little Fire Deutsche Bank characterizes the present situation as "a lot of smoke, but the fire is unclear," emphasizing that liquidity volatility should not be directly equated with a credit collapse. Furthermore, investors often mistake specific issues with individual investments for broader market trends, a classic case of misjudging correlation for causation. Although AI-driven selling is based on concerns about the long-term disruption of software companies, most software firms are likely to retain their customers and profits for now, meaning they should have cash flow available to service their debts in the short term. More importantly, given the strong performance of equity and credit markets, healthy corporate profits, a resilient U.S. labor market, and an overall robust economy, the conditions for a major collapse in confidence are not yet in place. For investors, the short-term focus should be on the four indicators listed by Deutsche Bank, and on whether the "net asset value discount" for vehicles like BDCs continues to spread. The real risk of localized issues turning into systemic contagion will begin when these discounts transition from being a sentiment indicator to a hard constraint on funding chains.