FT: "Rising Distressed Loans Heighten Private Credit Risks...Highest Since 2017"

The volume of distressed loans in the private credit market has reached its highest level since 2017. As large asset managers continue to report losses and warn of rising problem loans, concerns about the soundness of the market are spreading. However, some managers rebut that most loans are being repaid as scheduled and that the profits of borrowing companies are increasing, arguing that recent fears about defaults have been overstated.

Reuters Yonhap News

On August 17 (local time), the Financial Times (FT) reported, based on an analysis of data by bond information provider Solve, that the volume of distressed loans held by certain major private credit investors has risen to the highest level since 2017. The year 2017 was a period when the private credit industry struggled in the aftermath of a sharp drop in international oil prices.

According to Solve, among the 20 largest Business Development Companies (BDCs) investing in private credit, the median ratio of non-accrual loans by acquisition cost rose to 2.8% in the second quarter of this year. This marks an increase of 0.8 percentage points from 2.0% at the end of March. Non-accrual loans refer to distressed loans for which interest payments are not coming in on time and can no longer be recognized as revenue. The FT explained that the rise in the ratio of non-accrual loans signals increasing default risk in the private credit market. David Golub, co-CEO of Golub Capital, told investors earlier this month, "Credit market stress is rising," and added, "We are now in a credit cycle. There had been some denial about this for a while, but now that view has largely faded."

Global credit rating agency Fitch Ratings also analyzed last month that defaults in the private credit market had reached an all-time high. According to PitchBook LCD, major listed BDCs reflected valuation losses and saw their loan portfolios shrink in the second quarter, as the volume of loan sales and repayments exceeded that of new loan commitments. Particularly, FS KKR Capital, a listed fund managed by KKR, recorded a distressed loan ratio of 7.1% in the second quarter. Although this is slightly lower than the previous quarter, it still far exceeds the industry average.

Some argue that these concerns about defaults have been overstated. Executives in the private credit industry emphasized in their earnings reports that most loans are still being repaid as scheduled and that the profits of the borrowing companies are generally increasing. Craig Packer, co-president of Blue Owl, stressed, "Credit indicators are sound, and the current issues under management are limited to certain cases."

The FT pointed out that current defaults and losses mainly stem from investments made in 2020–2021, when low interest rates coincided with high company valuations. At that time, private equity funds were aggressively acquiring companies, and private credit funds provided substantial support for these takeovers. Subsequently, as interest rates rose, many borrowing companies have struggled to repay their debts. Brian High, Head of Global Private Finance at Barings, stated, "Some companies are unable to invest properly because of high borrowing costs," adding, "Most of the cash they generate is being used to pay interest, which is also limiting their growth."

In response to these circumstances, firms such as BlackRock have begun to restructure their portfolios. BlackRock’s TCPC sold $523 million worth of loan assets to improve its financial structure and is considering additional asset sales or liquidation going forward. Some funds, such as those managed by KKR, have opted not to receive part of their performance fees. Mitchell Penn, an analyst at Oppenheimer, pointed out that over the past five years, the average return on equity of the bottom 25% of funds has failed to exceed the yield on 10-year U.S. Treasury bonds, stating, "Loan screening and selection have not been sufficiently rigorous."

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