Private credit defaults record largest quarterly jump, KBRA says

The number of companies defaulting on private credit obligations rose by the most on a quarterly basis on record, according to Kroll Bond Rating Agency (KBRA). In a report published Thursday, KBRA said 112 borrowers with private debt defaulted, a 22% increase from the previous quarter. The firm's analysis covered more than 3,000 middle-market companies with over $1.4 trillion of direct-lending debt over the 12 months through September.

Smaller borrowers accounted for much of the deterioration. KBRA defines lower middle-market firms as those with $100 million or less in debt and EBITDA of $25 million or less, and core middle-market firms as those with more than $100 million but less than $500 million in debt and EBITDA between $25 million and $75 million. By count, about 5.8% of lower middle-market firms defaulted over the twelve months through the third quarter, up from 4.8% in the prior quarter. Core middle-market defaults rose to 3.7% from 3.2%. By contrast, upper middle-market defaults declined to 2% from 2.3%.

John Sage, head of private credit research at KBRA, described the pressure as cumulative, citing the pandemic, inflation and higher base rates. "It's death by a thousand cuts," he said. "The cost of debt is higher, sales growth across virtually every sector has been on the decline, and sponsor support is starting to fall away."

Bill Cox, KBRA's chief rating officer, said smaller companies are more prone to business-model problems and difficulty managing debt. "If you haven't been able to refinance into lower spreads, it's typically because your business model isn't working out – prolonged pressure from higher interest rates will only expose that," he said. Borrowing costs have remained elevated as inflation has stayed entrenched, complicating refinancing for companies issuing or rolling over debt.