A $770 Billion Wall of Stressed Credit Is Baked into the System Regardless of the Economy

What's New

Holly Kim of Glendon Capital, Brett Klene of Sculpture Capital, Susie Gibbons of Davidson Kempner, and Matthew Rakmani of Pella Weinberg Partners argued that a structural default cycle is already underway and will accelerate independent of macroeconomic conditions in a panel at the Bloomberg Global Credit Forum. Davidson Kempner's analysis identified $770 billion in leveraged loan and direct lending credits with leverage above seven times and interest coverage below 1.5 times, a share that has doubled since 2019. The panelists described LME fatigue, a pipeline of inevitable defaults from the 2021 LBO vintage, and an industry moving toward resolution rather than further can-kicking.

Why It Matters

The market is in its third year of elevated default rates above 5%, making this the longest such cycle in over 20 years. It has gone largely unrecognized because it has manifested as a slow bleed of LME, non-contractual PIK, and amend-and-extend rather than the short, violent spikes that characterized the financial crisis, the energy downturn, and COVID. Allocators benchmarking against prior cycles will miss the pattern entirely. The panelists agree the next phase shifts from time-buying exercises to traditional restructurings where equity ownership changes hands.

Big Picture Drivers

• 2021 LBO vintage as embedded default pipeline: Roughly $2 trillion in leveraged transactions in 2021 and 2022 created the most highly levered balance sheets in the cycle. Kim identified $165 billion in LME paper across 66 issuers, with super-senior paper now trading at an average price in the 70s and $75 billion subordinated beneath it.

• Maturity wall that did not get solved: Despite wide-open refinancing markets in 2024 and 2025, an additional $500 billion in maturities over the next two years still needs to be addressed. Many of those borrowers did not refinance because they could not access the market.

• LME fatigue reaching a breaking point: Investors increasingly reject amend-and-extend for its own sake. A third of LME transactions have ended in bankruptcy. Klene described an investor base saying "no more" after LME devolved from a creditor tool into a competitive race to the bottom among advisory groups. The two-year fraudulent conveyance lookback tied to approaching maturities is forcing boards and sponsors to think harder about leaving companies more insolvent through aggressive transactions.

• EBITDA addbacks masking true leverage: Addbacks in direct lending have roughly doubled over the last decade. What was a one-turn differential between actual and adjusted earnings has expanded to two turns, meaning loans that appeared to be at 45% loan-to-value were actually at 65%.

• Private and public credit markets now compete for the same borrowers: The notion that private credit has its own borrower base and public credit has its own went away over the past several years. Borrowers survey both markets and sometimes approach the same lender through two different teams.

By The Numbers

• $770 billion — Leveraged loan and direct lending credits meeting Davidson Kempner's stress criteria of leverage above 7x and interest coverage below 1.5x, roughly a third of those markets

• $165 billion — Outstanding LME paper across 66 issuers, with super-senior tranches averaging prices in the 70s

• $500 billion — Maturities in the next two years that still need to be refinanced, many by borrowers who could not access the market previously

• 60% — Share of the high yield index now rated double-B, reflecting a quality upgrade as lower-quality borrowers migrated to private credit

• 10x to 5.5x — Multiple compression in cable broadband providers like Comcast and Charter, turning leverage that was manageable into an overleveraged $200 to $300 billion problem

Key Trends to Watch

• Equitization transactions replacing traditional LME: Rakmani described a shift toward deals where lenders receive equity if milestones are not met, including the "stock in a box" structure. These are called LME but function as restructurings and reflect creditor insistence on resolution over extension.

• Creditors running the clock on fraudulent conveyance windows: With maturities clustering in 2027 and 2028 and bankruptcy carrying a two-year lookback, creditors are strategically delaying to force boards into more creditor-friendly conversations. The negotiation dynamic has shifted markedly.

• Direct lending secondaries as an emerging opportunity set: Gibbons argued that broken capital structures often contain good companies starved of investment by sponsors focused on time-buying rather than operations. Opportunistic credit investors with restructuring capabilities will find opportunities as direct lending opens to secondary transactions.

• Stagflation risk compounding the structural default cycle: Kim flagged that the first dollar of gas price increases was absorbed by fiscal stimulus, but the next dollar stands on its own. Wages have already turned negative, and the Fed may be unable to bail out the consumer given the inflationary dimension of the current energy shock.

Memorable Quotes

• "There is a pipeline of defaults that are already baked into the system from the LBO bubble from 2021. Whether we have a recession or not, we are going to have a default cycle." Kim frames the coming wave as structural, not contingent on macroeconomic deterioration.

• "I just believe in laws of physics. If you have been charging 200 basis points over your competitor for a long period of time, you're going to have losses." Klene on the inevitability of private credit loss recognition after years of premium pricing over leveraged loans.

• "What fell out of favor is lending money and investing in secular declining low-quality businesses for a little bit of extra money, which you never get." Klene captures the investor disillusionment driving the pullback from LME-dependent strategies.

• "We're actually already in the third year of an elevated default cycle. It just hasn't felt like other cycles because there have been no short spikes with immediate restructurings. It's been this slow bleed." Gibbons on why the current cycle is hiding in plain sight.

The Wrap

The panelists are describing a default cycle that has already been running for three years but has been obscured by the mechanics of its own deferral. LME, non-contractual PIK, and amend-and-extend created the illusion of stability while stress metrics doubled. The $770 billion in fundamentally impaired credit identified by Davidson Kempner exists independently of whether the economy weakens, and LME fatigue means the industry's preferred mechanism for delay is losing both creditor tolerance and legal viability. The question for allocators is not whether restructurings are coming but whether their managers are positioned for the recovery values that will actually materialize, values that the BSL tech loan market has already revealed to be far lower than the industry's muscle memory suggests.