Deferred interest payments and maturity extensions are masking the extent of stress among US private credit borrowers, according to a report by Bloomberg citing research from Moody’s Ratings.
The default rate among 607 borrowers assessed by Moody’s was 4% in the 12 months to June. It rose to 5.8% when payment-in-kind (PIK) amendments and maturity extensions involving distressed borrowers were included. The agency treats these arrangements as distressed exchanges equivalent to defaults.
Recent financial statements reportedly showed that 17%d of borrowers in the sample used PIK interest, which adds interest to outstanding debt instead of requiring cash payments. This preserves cash in the short term but increases borrowers’ debt burden.
Companies using PIK showed weak liquidity, negative free cash flow and high leverage, with interest coverage around break-even levels. Financial strain was similar whether PIK provisions were included when loans were originated or introduced later.
Business services companies using PIK had the highest concentration of weak liquidity, while software borrowers recorded the weakest credit metrics overall.
Refinancing pressures could add to the strain. Lower-rated issuers account for more than half of debt maturities due in both 2027 and 2028 within Moody’s sample, leaving weaker borrowers reliant on extensions, PIK amendments, costly refinancing or further support from private equity sponsors.
Borrower stress has yet to cause significant deterioration in the middle-market collateralised loan obligations holding much of the debt. Moody’s said portfolio management, collateral tests and structural protections had so far helped shield CLO investors from weakening borrower credit quality.
