Private Credit Enters Its Hardest Test in Nearly a Decade
Troubled loans are rising across listed private-credit funds, exposing the cost of boom-era underwriting and testing a $2 trillion asset class.
Private credit’s long expansion is meeting its clearest credit-cycle test since the oil-price shock of the mid-2010s. An analysis published by the Financial Times on Monday found that non-accrual loans among the 20 largest publicly traded business development companies, or BDCs, rose to a median 2.8% of loan cost in the second quarter. That was up from 2% at the end of March and returned the measure to levels last seen in 2017.
Non-accrual status does not mean every affected borrower has failed. It does mean a lender has stopped recognising interest as income, or believes scheduled payments have become doubtful. The increase therefore matters less as an isolated percentage than as evidence that stress is broadening across portfolios assembled during unusually easy financing conditions.
The pressure is visible in both asset quality and growth. At listed vehicles managed by KKR and Blue Owl, as well as Apollo’s MidCap Financial, loan repayments and asset sales outpaced new commitments during the quarter. FS KKR Capital reported that 7.1% of its loan book was troubled, still well above the sector’s average despite a small sequential improvement. When repayments exceed new lending, fee-producing assets can shrink precisely as managers need more earnings capacity to absorb losses.
Several problem credits trace back to the acquisition boom of 2020 and 2021. Private-equity sponsors bought companies at elevated valuations while benchmark rates sat near zero, then financed those deals with floating-rate debt. The subsequent rise in rates transferred much of the monetary tightening directly to borrowers. Cash that might have funded hiring, product development or acquisitions instead went to interest. Businesses with optimistic entry valuations and limited pricing power had little margin for error.
Software, a large component of many BDC portfolios, is an important fault line. Lenders including Blackstone and KKR marked down debt issued to Medallia after owner Thoma Bravo handed the business to creditors. Blackstone valued its exposure below 50 cents on the dollar at the end of June, down from 60 cents in March. Ares marked down a loan to Cornerstone OnDemand, while lenders took control of dental-services group Affordable Care after a default. These are not anonymous tail risks: they show how sponsor-backed companies can migrate from covenant negotiation to ownership transfer when refinancing options narrow.
Market prices are already imposing a discount. Listed BDCs managed by KKR and BlackRock have lost more than 15% over the past year, while Apollo’s vehicle is down 14.5%. Some competitors have recovered, and industry executives argue that most loans continue to perform. Blue Owl has described its problems as isolated, and Ares says portfolio leverage and interest coverage remain near five-year averages. Both propositions can be true: the majority of loans may remain current while the weaker vintage produces disproportionate losses.
The more consequential question is how portfolios manage that dispersion. BlackRock’s TCPC vehicle sold a $523 million block of loans to strengthen its balance sheet and hired advisers to consider options that could include an asset sale and wind-down. KKR has waived some incentive fees at its challenged vehicle. Those measures protect liquidity and align managers with shareholders, but they also acknowledge that the sector cannot rely on asset growth alone to repair weak underwriting.
Private credit remains structurally important. Banks retreated from parts of middle-market lending after the financial crisis, leaving private funds to provide flexible capital to companies that often lack access to public bond markets. The asset class now manages roughly $2 trillion and channels savings from insurers, pensions and wealthy individuals into corporate loans. Its opacity, however, makes price discovery slower than in syndicated loans or public bonds. Valuations are periodic, restructuring terms are private, and reported non-accrual rates can lag the deterioration that managers see internally.
Why it matters
This is a test of whether private credit can absorb a normal default cycle without turning a liquidity problem into a confidence problem. Borrowers face higher refinancing costs and less tolerance for missed plans. Investors must distinguish contractual yield from realised return after restructurings, fee waivers and markdowns. Asset managers face pressure to show that valuations are credible and that troubled credits are being resolved rather than extended indefinitely.
The current evidence does not establish a systemic crisis. It does establish a cycle. The key indicators now are the direction of non-accruals, the gap between repayments and new commitments, recovery values after restructurings and whether redemptions force further portfolio sales. If credit performance stabilises, today’s discounts could prove overly severe. If the 2020-2021 vintage continues to deteriorate, the industry’s rapid growth will receive a much more demanding audit from its own balance sheets.