Private Credit Defaults Nudge Up: A Warning?

The burgeoning asset class of private credit saw its default rate rise in this year’s second quarter to its highest level since the 2020 pandemic year, one which featured a recession.

This year’s second period had a 2.71% default rate, the third consecutive quarter that default levels have risen, according to a study by Proskauer Rose LLP, the large international law firm that specializes in finance.

In 2020’s second quarter, defaults hit a decade high of 8.2%. Then, as vaccines became available and the short recession faded, the rate tumbled to a low of 1.0% in 2021’s final quarter.

In 2024’s second quarter, the magnitude of defaults was similar regardless of company profitability, gauged by Proskauer on earnings before interest, taxes, depreciation and amortization: From the smallest, less than $25 million (2.6% in the second quarter), to the largest, greater than $50 million (2.8%).

Want the latest institutional investment industry news and insights? Sign up for CIO newsletters. 

The latest private debt default reading hardly means ongoing deterioration is unavoidable for the asset class, the Proskauer report argued. Indeed, Steve Boyko, a partner in Proskauer’s private credit group and co-chair of the firm’s corporate department, characterized the rising default rate as a warning. Defaults “are not necessarily indicative of distress; instead, they provide managers with the ability to take steps to reduce their risk, ” he said in a statement.

The popularity of private credit has grown quickly, propelled by its lush yields, around 8.2% for the 12 months ending in 3Q 2023. The asset class attracted $1.75 trillion globally (mostly in the U.S.) as of mid-2023, tripling its size over 10 years, a PitchBook report indicated.

Some problems with private debt investments, which are made mostly to small businesses, have come to light recently, however. Example: Swiss bank Julius Baer announced in February it would end its private debt business after reporting net losses of $679 million due to its exposure to troubled Austrian commercial real estate owner Signa.

Weaknesses in the private lending space are less pronounced than those of syndicated loans (mostly bank lending to highly indebted companies, known as leveraged loans, which are then often consolidated into non-publicly traded pools) and junk bonds. For the 12 months ending in May, syndicated loans and high-yield debt had a combined default rate of 4.33%, per Fitch Ratings. The average leveraged loan is almost twice as big as a loan in the private credit sector—$80 million versus $47 million, per Fitch.

The big question about private credit, in the view of Jamie Dimon, the JPMorgan Chase CEO, is how it will fare when a recession arrives. He has noted that, as a relatively new asset class, it has not weathered a full economic cycle and offers little history to guide investors.

“Frequently, the weaknesses of new products, in this case private credit loans, may only be seen and exposed in bad markets, which private credit loans have not yet faced,” he wrote in the bank’s latest annual report, released in April.