UBS Now Sees Private Credit Defaults Reaching 15% in Worst Case

(Bloomberg) — A few weeks ago, analysts at UBS Group AG laid out a worst-case scenario for defaults in the private credit sector. Their outlook is even more grim now.

Strategists including Matthew Mish now say private credit could see default rates surge as high as 15%, two percentage points more than a forecast the firm published less than a month ago.

The initial report had warned that direct lenders could face a 13% default rate if artificial intelligence triggers an “aggressive” disruption among corporate borrowers, but that view became even more bearish in recent weeks as fears about AI upending the US economy deepened.

“What is new: a clearer catalyst — rapid, severe AI disruption,” said the report published on Tuesday.

Fears of such an event have been building in recent days. Stocks slid to start the week after a report from Citrini Research spooked investors with a scenario where AI advancements led to a double-digit US unemployment rate by 2028. And just days prior, Blue Owl Capital Inc. blocked investors from making withdrawals from one of its private credit funds, raising anxiety about the loans issued by direct lenders, especially to software firms.

“The most acute risk is a sector-specific shock triggering cascading defaults,” the UBS strategists wrote. “Technology is especially vulnerable to disruption from AI adoption or rapid retrenchment.”

They added: “Private credit defaults are reportedly between 3% and 5%, and signs of strain —such as interest paid-in-kind — are nearing post-pandemic highs.”

The strategists also see higher default risk for leveraged loans and high-yield bonds, where they project rates of up to 6% and 10% in a worst-case scenario. That’s up from estimates of up to 4% and 8% in the previous report.

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