Markets: More than 600 US debtors surveyed: Stress in the private credit market is greater than previously assumed

Moody's fears that the official figures systematically underestimate the actual defaults in the private loan market. The pressure is likely to grow from next year.

Moody's analyzed 607 mid-sized U.S. companies and found that the default rate on corporate loans due to hidden defaults increased from 4.0 percent to 5.8 percent.

According to Deutsche Bank Research, the proportion of interest deferrals based on the “Payment in Kind” (PIK) principle in American business development companies is almost ten percent and eleven percent in the middle market segment according to Lincoln International.

Moody’s sees no differences in credit quality between loans with an initial or subsequent PIK option, as both groups exhibit similar financial weaknesses.

The business and consumer services and software industries contribute more than half of the defaults, while loans with weak credit ratings account for over half of the 2027 and 2028 maturities.

Frankfurt. The rating agency Moody’s warns of new risks in the controversial market for private credit. A new study concludes that reported default rates for corporate loans issued by investment vehicles outside the traditional banking system paint an overly positive picture.

For the study, the analysts evaluated 607 medium-sized US borrowers. In the twelve months up to June 2026, 4.0 percent of companies reported a failure. However, if you take into account events that Moody's considers to be hidden defaults, the rate rises to 5.8 percent.

The market for private credit has grown rapidly in recent years towards two trillion dollars. However, supervisors such as the German Bafin, the European Central Bank and the International Monetary Fund have been warning for years about growing risks for the financial system due to a lack of transparency and weak regulation.

Among the hidden failures in the private credit market, Moody’s includes interest deferrals based on the “Payment in Kind” (PIK) principle and term extensions. PIK stands for contractual clauses for loans with which interest payments are deferred until the end of the term. These clauses enable companies to conserve cash in the short term because no funds are used for interest payments.

According to Deutsche Bank Research, the PIK share in the portfolios of American business development companies rose to almost ten percent. It was only higher in 2020 and 2021. These are investment vehicles that issue shares to professional and semi-professional investors. They pass on the collected capital to companies in the form of loans.

The investment bank Lincoln International puts the PIK share in the middle market segment at eleven percent, in 2021 it was only seven. Almost 60 percent of these are considered “bad PIK”: loans that started as conventional loans and were later converted. An increasing proportion of PIK loans is seen as a sign of growing financial stress among highly indebted companies.

The Moody’s experts come to the conclusion that it makes no difference to the credit quality whether the PIK option was agreed upon when the loan was granted or was only added later. Both groups would show weak liquidity, negative free cash flow and high debt - and thus similar symptoms to those companies whose loans have already defaulted.

Two industries are particularly hard hit by the failures identified by Moody’s. Business and consumer services and software are responsible for more than half of the failures.

According to Moody’s, the pressure on the private credit market is likely to continue to increase. Debtors with a weak credit rating make up more than half of the loans due in 2027 and 2028, and around a third of those due in 2029 and 2030. According to the rating agency, many of them are dependent on extensions, further PIK agreements, expensive refinancing or help from their owners.