Private Credit Stress Builds Among Smaller Borrowers

Stress in private credit is widening beyond the smallest borrowers, but defaults and loan markdowns remain concentrated among companies with less than $100 million of EBITDA, according to Houlihan Lokey.

The investment bank’s Private Credit DataBank found that borrowers below that threshold recorded a 3% size-weighted default rate in the second quarter and a 3.6% rate by borrower count. The measure includes technical defaults, such as covenant violations, as well as missed payments.

Across the full market, defaults represented 0.8% of outstanding principal and 2.5% of borrowers. The difference reflects the stronger performance of larger companies, Houlihan Lokey said.

Loan valuations show a similar divide. Twelve percent of loans to borrowers with $10 million to $20 million of EBITDA were valued below 90% of par, up from roughly 1% in 2023. The share reached 6% among borrowers with $20 million to $100 million of EBITDA, its highest in three years, compared with 3% for companies above $100 million.

“The increase is concentrated, not broad,” said Cindy Ma, Houlihan Lokey managing director and global head of Portfolio Valuation and Fund Advisory Services. She expects borrower size to remain a defining performance factor through year-end.

Payment-in-kind provisions also reached a record level, although actual use remained limited. Loans electing some PIK interest represented 11.8% of principal and 6.3% of interest dollars. Amended PIK, which adds the feature after origination and can signal stress, accounted for 1.6% of interest.

Borrower fundamentals remained positive overall: Median revenue increased 6.5% year over year, while median EBITDA rose 7.4%. More than two-thirds of borrowers grew both measures.

Software posted among the lowest sector default rates despite concerns about artificial intelligence disruption. Median software company EBITDA was 20% above its level when the loans originated, Houlihan Lokey said.