The private credit market is facing its biggest challenge in almost a decade, with mounting strains spreading across portfolios. An analysis of data from Solve, a fixed-income provider, reveals that the value of troubled loans held by some of the largest private debt investors has reached levels last seen in 2017. This comes after a period when the industry was recovering from an oil price crash. Loans placed on non-accrual status by the 20 largest publicly traded business development companies (BDCs) increased to a median of 2.8% of their cost in the second quarter, up from 2% at the end of March. This status indicates that borrowers have either stopped making payments or are believed to be at risk of default.
Several industry leaders acknowledge the elevated stress. David Golub, co-chief executive of Golub Capital, stated there was “elevated credit stress” and that the industry is in a “credit cycle.” Fitch Ratings warned that private credit defaults hit a new record in July, and PitchBook LCD data showed that BDCs shrank in the second quarter due as impairments and outpaced new deals. Firms like KKR and Blue Owl, as well as Apollo Global's MidCap Financial, saw repayments exceed new lending. FS KKR Capital Group reported 7.1% of its loan book as troubled, highlighting the difficulties.
The pain points are particularly evident in investments made between 2020 and 2021 when interest rates were low and private equity firms engaged in a buying spree at elevated valuations. Higher borrowing costs are now starving some businesses of investment capital, forcing them to use cash to pay interest to lenders, which stifles growth. Notable examples include Blackstone and KKR marking down a loan to software group Medallia, with Blackstone's fund valuing the investment at less than $0.50 on the dollar by June, down from $0.60 in March. Ares' fund wrote down its loan to Cornerstone OnDemand, and Blackstone and KKR took over Affordable Care after its default.
Despite these challenges, some executives, including Craig Packer, co-president of Blue Owl, and Jim Miller, who runs Ares’ US direct lending business, maintain that most loans are performing well and credit metrics are healthy. However, the sell-off in BDC share prices reflects investor concerns, with listed BDCs managed by KKR and BlackRock down over 15% in the past year, and Apollo's fund losing 14.5%. BlackRock even sold a $523 million block of loans and is exploring options for its vehicle, TCPC, including winding it down. Analyst Mitchel Penn of Oppenheimer notes that BDCs are “priced for death,” with some funds generating returns on equity below the yield of a 10-year Treasury, suggesting that “underwriting wasn’t as good as it should have been.”
