Borrowers in the US private debt market are using delayed interest payments and maturity extensions to avoid default, potentially masking the overall extent of credit stress, according to Moody’s Ratings. The default rate among 607 private credit borrowers assessed by Moody’s stood at 4% in the 12 months to June. That figure rose to 5.8% when payment-in-kind amendments and maturity extensions among distressed issuers were taken into account, the firm wrote in a report.
The rating agency views such tools as distressed exchanges and therefore equivalent to defaults. Payment-in-kind, or PIK, are arrangements that allow borrowers to delay interest by tacking it onto principal due. When added during the life of a loan to free up cash for operations, they also compound a company’s debt over the long term.
The findings highlight how lenders’ ability to amend loans and defer cash interest payments can obscure the extent of stress in private credit. That comes as borrowers contend with rising rates at a time when inflation, trade disruptions and the threat of AI obsolescence are eroding earnings. The pressure risks intensifying as borrowers approach a wall of debt maturities.
In the Moody’s sample, lower rated issuers account for more than half of maturities due in both 2027 and 2028, leaving many of the weakest borrowers dependent on extensions, PIK amendments, expensive refinancing or additional support from their private-equity sponsors. Recent financial statements for the 607 borrowers also showed that 17% were using PIK interest, which allows companies to add interest to their outstanding debt rather than pay it in cash, according to the report. Borrowers showed similar signs of financial strain regardless of whether PIK was available from the outset of the loan or introduced later.
The companies grappled with weak liquidity, negative free cash flow and high leverage, while interest coverage hovered around break-even levels, the report showed. Among borrowers using PIK, business-services companies had the highest concentration of weak liquidity, while software companies had the weakest credit metrics overall. Still, stress among individual borrowers has yet to translate into significant deterioration in the middle-market collateralized loan obligations that hold much of the debt.
Moody’s said portfolio management, collateral tests and stronger structural protections have so far helped insulate CLO investors from weakening borrower credit quality.
Source: Bloomberg Markets · Summarized by HeadlinesBriefing