U.S. private credit defaults rise as softer restructurings mask pressure

Traders Union
All News
Financial News
US private credit defaults rise

Highlights

Fitch reports the U.S. private credit default rate rose to 6.3 per cent in August, the highest in three years, with 14 defaults that month.
Flexible private credit restructurings, including payment-in-kind and maturity extensions, are being counted as defaults in Fitch's index, highlighting masked market stress.
Rising defaults stem from maturing loans, higher interest rates, and sluggish middle-market M&A, with borrowers often exposed to five to seven turns of floating-rate leverage.

Fitch data points to mounting stress

As reported by Financial Times, a note from Fitch last week says the U.S. private credit default rate is running at 6.3 per cent for the 12 months ending in August, the highest level in the three years the rating agency has tracked the market and up from 6.1 per cent in the previous month. Fitch records 14 private credit default events in August, the highest monthly tally in the past year and up from three in July.

Fitch has visibility into this corner of the market through two private debt portfolios. One includes middle-market loans originated by private credit managers and placed with insurance company clients that require ratings for regulatory reasons, while the other covers loans bundled into tradeable collateralised debt obligations that disclose the performance of individual borrowers. Together, the portfolios cover more than 1,650 borrowers.

In private credit, a default often does not trigger bankruptcy, a change of control or legal action. Randy Schwimmer of Churchill Asset Management says defaults in private markets frequently mark the start of negotiations, with lenders and borrowers using amend-and-extend agreements, payment-in-kind toggles and equity cures to buy time and work through stress.

Flexible workouts reshape market risk

Supporters of private credit argue that this flexibility can improve risk-adjusted returns versus public credit because a direct lender-borrower relationship may raise recoveries and reduce the chance of destructive fights among multiple creditors. That same flexibility may also help explain why broader corporate bond and syndicated loan markets remain relatively calm, as private lenders absorb weaker credits and continue supporting them when performance deteriorates.

Fitch, however, counts these softer outcomes, including payment-in-kind equity-for-interest swaps and negotiated maturity extensions, as defaults in its private credit index. Lyle Margolis of Fitch tells the publication that pressure is building in these portfolios and showing up in higher defaults, even if the rate is dominated by soft defaults.

Margolis says the rise reflects three factors, a wave of loans reaching maturity, higher interest rates and a slower market for middle-market mergers and acquisitions. He notes that many private credit borrowers use five to seven turns of leverage, often with floating-rate debt, and that selling a company to resolve a difficult capital structure is harder than it used to be.

Fitch's sample may not fully represent the roughly $2 trillion private credit industry, and the sector's relatively short history in its current form limits comparisons with past cycles. Even so, the combination of rising default rates and increasingly negotiated workouts suggests that some stress is being managed privately rather than disappearing.

In our earlier article on redemption pressure at Apollo Debt Solutions BDC, we explained that third-quarter tender requests fell to 14.7% from 16.8% in the prior quarter, suggesting some easing in withdrawal demand. However, the fund still planned to repurchase only 5% of shares, and it said most requests were re-tenders from earlier rounds—highlighting ongoing liquidity constraints for investors seeking to exit.

This material may contain third-party opinions, none of the data and information on this webpage constitutes investment advice according to our Disclaimer. While we adhere to strict Editorial Integrity, this post may contain references to products from our partners.