Private Credit Cracks Are Widening. Redemption Gates at Morgan Stanley and Apollo Are the Visible Part.

Since the broader semiconductor and AI capital-spending story began dominating financial headlines this month, a quieter but potentially larger credit problem has been building in a corner of the market that most retail investors have never heard of. Private credit — the $1.8 trillion universe of direct loans made outside the banking system — is now showing enough strain that fund managers are locking the exits.

Morgan Stanley has capped investor withdrawals at 5% from its $7 billion private credit fund, according to 247 Wall St. Apollo Global Management is again limiting redemptions from its largest non-traded retail private credit product. Both moves came as withdrawal requests across the asset class spiked this quarter.

The Numbers Behind the Anxiety

The CEF Advisors BDC index is down roughly 8% on a total return basis year to date, even after recovering about 2% quarter over quarter, according to AICA's quarterly earnings analysis. The one-year discount has widened by approximately 18 percentage points. That is a repricing, not noise.

Paul Johnson, Managing Director at KBW, told AICA that nearly half of the BDCs in his coverage missed earnings estimates in Q1 2026. Eight or nine companies cut dividends that quarter alone, on top of roughly ten that cut the quarter before. Johnson's assessment: the sector is "probably only about halfway through" the dividend reset, and earnings are still "troughing."

Even Ares Capital, which analysts treat as the quality anchor of the BDC space, missed KBW's estimate by two cents and missed consensus by one cent. When the sector's strongest franchise can't clear a low bar, Johnson said, you're not looking at isolated stumbles.

Dan Altscher of FJ Capital Management, who invests in these names professionally, told AICA the quarter came in "weaker than even my fairly low bar expectations." His diagnosis: spread compression didn't just hurt coupon income. It also dried up the one-time fees — original issue discount, prepayment penalties — that had quietly padded results in better years.

Tannenbaum's Warning

Len Tannenbaum, the founder of Tannenbaum Capital Group who built Fifth Street Asset Management to roughly $5 billion in assets before selling it to Oaktree in 2017, is now positioning to profit from the stress he's describing. He and his son Adam are planning a new business development company targeting the lower-middle-market, specifically companies generating $5 million to $25 million in EBITDA, according to Crypto Briefing. Specific fund size and launch timeline have not been disclosed. His current firm manages approximately $1 billion and has committed nearly that full amount to real estate lending through Sunrise Realty Trust (NASDAQ: SUNS) since early 2024.

On Bloomberg Businessweek, Tannenbaum said the redemption gates at Morgan Stanley and Apollo are predictable results of how the asset class scaled. A large volume of direct loans was originated in 2021 and 2022 when rates were near zero, underwritten without accounting for the rate environment that followed. As of June 24, 2026, the five-year Treasury yielded 4.15%, the 10-year sat at 4.38%, and the 30-year reached 4.85%, according to 247 Wall St. A software company that borrowed at roughly 7% all-in now faces refinancing closer to double digits.

When that math stops working, Tannenbaum says the loan doesn't go to default. It gets quietly restructured into a payment-in-kind, or PIK, security. The borrower pays interest with more debt instead of cash. He estimates PIK loans now represent 12 to 15% of the entire private credit market, a figure higher than some other industry estimates. The lender's books look healthy because income is still being accrued. The cash isn't actually arriving.

BDC and non-traded fund managers are carrying private loans at marks between 70 and 90 cents on the dollar, according to Tannenbaum, and he doubts those marks would survive a real transaction. He borrowed a Goldman Sachs line to make the point: "If you really want to find a price, sell 10% and I'll tell you what the price is." The Level 3 fair-value inputs that dominate BDC loan books — visible in Apollo's 10-Q filings with the SEC — are, by definition, not tested by actual market bids.

The Counterargument Deserves a Hearing

Goldman Sachs and JPMorgan, both with significant skin in this market, frame recent high-profile blowups at First Brands, Tricolor, and Cantor Group as isolated, issuer-specific events rather than indicators of systemic risk, according to 247 Wall St. JPMorgan's 2026 outlook similarly characterized recent defaults as concentrated in the auto sector and tied to company-specific problems. Goldman does acknowledge that U.S. banks carry roughly $360 billion in private equity and private credit loans, about 11% of their total loan books, but stops well short of calling it a systemic problem.

That's the strongest good-faith case for calm: defaults remain concentrated, the largest managers have navigated prior credit cycles, and lower-middle-market lending has historically been more resilient precisely because deal sizes are smaller and lender relationships are tighter. Tannenbaum himself is targeting that segment, which implies he sees value there, not just danger.

What neither Goldman nor JPMorgan can answer cleanly is whether the Level 3 valuations holding up reported NAVs would survive forced selling at scale. It's an accounting question the redemption queues at Morgan Stanley and Apollo are beginning to force into the open.

The unresolved question heading into Q2 2026 earnings season: whether the remaining BDC dividend cuts Johnson at KBW expects will stay contained to the weaker managers, or whether spread compression and PIK proliferation are systemic enough to hit balance sheets across the board.