Emerging “Bifurcation” of Quality in Mid-Market Private Credit
Rating downgrades among the weakest middle market private credit issuers increased in the first quarter of 2024, despite overall positive trend developments.
According to the most recent update from credit agency Morningstar DBRS, issuers rated CCC (high) or lower now make up 6% of its portfolio. That remains the same from the end of 2023 but up from 2% at the end of 2022. This includes 0.3% of the issuers downgraded to D during the quarter.
Meanwhile, despite persistently high borrowing rates, lenders’ demand for private credit underwriting looks healthy, as seen by a year-to-date increase in new lender private rating requests.
“After reviewing each of the members of the high-risk group, we find no significant concentration of end markets that would signal risk of broader sector-wide contagion,” wrote the authors.
Morningstar provides lender-solicited private credit ratings for over 350 borrowers in North America, the U.K., and Europe. Borrowers are typically highly leveraged companies with average operational earnings of less than $50 million equivalent, which fall under the “middle market” category of private credit.
“We estimate that another 4% to 6% of the total private credit portfolio is currently operating under some form of covenant waivers or amendments to sidestep technical defaults,” Moringstar added.
“We believe that some portion of these borrowers, which are currently rated B (low) or better, will be able to recover, but recognize that the credit quality of others is likely to weaken further, potentially contributing to future growth in the CCC (high) or lower group.”
Downgrades surpassed upgrades by 2.6x in the first quarter, up from 2.3x the previous year. However, the ratio fell dramatically from a recent high of 5.7x in the fourth quarter of last year, although it remains within the range of most of last year.
Morningstar stated that new credit ratings inflows this year have been more biased toward issuers with relatively stronger credit quality (those awarded credit ratings of B (high) and above). Inflows have been mostly concentrated in the Services and Consumer sectors, with a lower share of Industrial Products issuers.