Private credit stress mounts as troubled loans reach highest level since 2017

Private credit is facing renewed pressure as the proportion of troubled loans held by major lenders rises to levels not seen since 2017, highlighting growing risks across the $2tn asset class, according to a report by the Financial Times.

The report cites analysis of data from fixed-income provider Solve as finding that non-accrual loans at the 20 largest publicly traded business development companies (BDCs) reached a median 2.8% of loan cost in the second quarter, up from 2% three months earlier.

Non-accrual status is used when borrowers stop making payments or lenders believe a default may be imminent, making the measure an important indicator of credit stress.

The deterioration comes as private credit managers contend with rising defaults, weaker loan valuations and limited new-deal activity. Fitch Ratings recently reported that private credit defaults reached a record level in July, while data from PitchBook LCD showed that the largest listed BDCs contracted during the second quarter as repayments and loan sales exceeded new commitments.

Funds managed by KKR, Blue Owl and Apollo Global Management were among those where repayments outpaced new lending. KKR’s FS KKR Capital Group reported that 7.1% of its loan portfolio was troubled during the quarter. Although that represented a modest improvement from the previous quarter, it remained well above the sector average.

The deterioration is putting pressure on a sector that has become a major growth engine for alternative asset managers. Private credit has attracted substantial capital from insurers, pension investors and wealthy individuals, helping drive rapid expansion at managers including KKR, Blue Owl, Ares Management, Blackstone and Apollo.

However, weaker returns and concerns over liquidity have weighed on listed private credit vehicles and, in turn, the share prices of their managers.

Private credit executives are increasingly acknowledging that defaults, restructurings and bankruptcies are returning towards more normal historical levels after years of unusually low losses.

The pressure is particularly concentrated among companies financed during 2020 and 2021, when near-zero interest rates encouraged private equity firms to pursue acquisitions at elevated valuations. Many of those businesses are now struggling to absorb higher borrowing costs.

Software companies are a particular area of concern, with lenders facing uncertainty over whether revenue growth can withstand changes in corporate technology spending as companies redirect budgets towards artificial intelligence.

Several major lenders have already marked down loans to struggling borrowers. Blackstone and KKR reduced the value of their positions in software company Medallia, with Blackstone’s fund valuing its loan at less than 50 cents on the dollar at the end of June, compared with 60 cents three months earlier.

Ares also cut the value of its loan to human resources software provider Cornerstone OnDemand, while lenders including Blackstone and KKR took control of dental services company Affordable Care after it defaulted.

Despite the growing number of problem loans, major private credit managers have sought to play down concerns about widespread deterioration. Blue Owl said credit metrics remained healthy and that problems were largely isolated, while Ares said borrowers were generally maintaining solid interest coverage and leverage ratios.