Private credit is increasing in popularity, as allocators continue their shift toward alternatives. The economy also is growing nicely, which bodes well for keeping defaults at bay.
Still, Moody’s Ratings delivered some disquieting news last week about one corner of private credit, business development companies, where overall returns have been good. The ratings agency assigned negative outlooks to three of the more celebrated such vehicles, noted for their size and parentage: FS KKR Capital Corp. (the second largest BDC by assets, $15.5 billion), Oaktree Specialty Lending Corp. (12th largest at $3 billion) and BlackRock TCP Capital Corp. (26th, $1.6 billion).
Offsetting Moody’s downbeat assessment: All these three publicly traded stocks rose last week, bad news be damned. KKR climbed 1.9%, Oaktree 2.4% and BlackRock 1.2%.
Moreover, the news has not troubled the rest of the BDC publicly traded space. The S&P BDC Index also shrugged off the Moody’s assessment as the index continued to advance during the week.
In fact, the index, which had a good year in 2023, up 15%, is ahead 3.3% this year through last Friday. That is slightly better than junk bonds, at 3.1% in 2024, and the Bloomberg U.S. Agg, which covers investment-grade bonds, at negative 3.1%. Fixed income is in a wait-and-see mode as long-expected Federal Reserve rate decreases are on hold.
All three of the BDCs that Moody’s warned about sport Baa3 ratings, the last tier above junk status. A high-yield rating would mean loftier borrowing costs for these BDCs. This marks the first such negative outlook for private credit by Moody’s since 2020. Oaktree declined to comment, and the other two did not respond to requests for their reaction.
While Moody’s stated that they all are handling their lending operations well, it pointed to a worrisome rise in their non-accrual loans, meaning those where borrowers have fallen behind on interest payments. James Morrow, founder and chief executive of Callodine Capital Management, an investor in public BDCs, told Bloomberg that he attributed the rise in non-accruals to higher interest rates, which do not appear likely to fall anytime soon.
In the fourth quarter, these laggard borrowings doubled at the three BDCs, and stood at 6.4% of loans outstanding for KKR, 4.5% for Oaktree and 1.2% for BlackRock. One example is a $47 million Oaktree loan to online retailer Thrasio LLC, which filed for Chapter 11 bankruptcy protection in February.
For KKR, Moody’s commented that it downgraded the private credit vehicle “to negative from stable based on the BDC’s asset quality deterioration and its effect on earnings and capital strength.”
BDCs are closed-end investment companies that invest in small and medium-sized privately held businesses and offer rich annual dividend yields, which S&P Dow Jones Indices place at an average 10.2%, far above the S&P 500’s 1.3% and junk bonds’ 8.1%. The trio that Moody’s warned about yields higher than the BDC average, with KKR at 14.3%, Oaktree at 11.3% and BlackRock at 16.5%.
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Tags: BDCs, BlackRock, business development companies, KKR, Moody's, non-accrual loans, Oaktree, Private Credit, S&P BDC Index, Thrasio
