Cracks emerge in private credit

PUBLICLY traded private credit funds are showing growing signs of strain, with a Reuters analysis finding that more than half of listed business development companies (BDCs) have slipped into losses.

Falling asset values, higher funding costs and mounting loan pressures are reshaping one of finance’s fastest-growing sectors.

The findings come at a time when the US$3.5 trillion private credit industry is under increasing scrutiny from investors and regulators alike.

After years of rapid expansion, the sector is facing tougher questions over valuations, leverage and borrower resilience, particularly as artificial intelligence (AI) reshapes industries, such as software, where private credit lenders have significant exposure.

According to Reuters, an analysis of balance sheet data from S&P Global Market Intelligence covering 53 publicly traded BDCs found the group collectively became unprofitable in the first quarter of 2026 (1Q26) – the first time this has happened since at least 2024 under S&P’s standardised profit measure.

Unlike the industry metric that investors typically focus on – net investment income – S&P’s methodology incorporates changes in the value of loan portfolios alongside borrowing costs to produce a bottom-line profit figure.

While companies continue to report results using conventional industry measures, Reuters say the broader profitability metric offers a more complete picture of the financial health of listed private credit funds.

Across the 53 companies analysed, average profit swung to a loss of US$7.6mil in the 1Q26 from an average profit of US$26mil a year earlier, according to S&P data cited by Reuters.

Reuters also calculated 28 of the 53 BDCs were loss-making during the quarter, compared with just 12 a year earlier and 10 in 2024.

The calculations were reviewed by three academics, two industry analysts and S&P Global itself.

Markdown in values

The deterioration has been driven largely by markdowns in loan values, reflecting growing concerns about the ability of some borrowers to withstand a more challenging operating environment.

Software companies, many of which are grappling with disruption from rapid advances in AI, have emerged as one area of particular concern because of private credit’s sizeable exposure to the sector.

For investors, the findings suggest that valuation pressures are now spreading more broadly across the industry rather than remaining confined to isolated problem loans.

“It is a sign. Fund managers are marking assets down more widely than we’ve seen in this cycle,” Leyla Kunimoto, founder of Accredited Investor Insights, has told Reuters after reviewing the analysis.

She adds broader markdowns would ultimately translate into lower returns for investors.

Kunimoto also says the data suggest the private credit market is entering a new phase where lenders are reassessing loan values across their portfolios, rather than treating credit deterioration as a series of individual cases.

The pressure extends beyond asset valuations.

Reuters find that funding costs have continued to climb as interest expenses rise across the sector.

S&P data show average interest expense at listed BDCs has increased by roughly one-fifth over the past two years, rising from around US$23mil to approximately US$28mil.

Income-boosting structures

At the same time, Reuters reported that many funds are increasingly relying on financing structures that can boost reported income without immediately generating cash.

One example is payment-in-kind (PIK) financing, where borrowers pay interest by adding it to outstanding debt instead of making cash payments.

While the accrued interest is recognised as income by lenders, it also increases leverage.

Steve Novakovic, managing director of educational programmes at the CAIA Association, says that while PIK income may eventually benefit investors, it remains non-cash income and can provide an early indication of weakening credit quality.

Fitch Ratings data cited by Reuters show PIK income accounted for an average 8.1% of BDC interest and dividend income during 2025, up from 7.7% a year earlier and roughly double the levels recorded before 2020.

Reuters also points to growing use of off-balance-sheet borrowing through joint ventures and special-purpose vehicles.

These financing structures are permitted under existing regulations and are not included in regulatory leverage calculations, although they can increase overall borrowing exposure.

Using AlphaSense financial data, Reuters has reviewed company filings and found only 14 BDCs disclosed complete information on their joint ventures.

For those companies, adding the off-balance-sheet borrowings back into their balance sheets show total borrowing increased by around 80% throughout 2025, followed by another 14% during the 1Q26.

Huge investment losses

While Reuters notes there is no suggestion of any regulatory breaches, the growing use of these structures illustrates how leverage in the sector may be expanding beyond headline balance sheet figures.

Individual funds have also begun recognising larger investment losses.

According to Reuters, Blue Owl’s OTF fund recorded a US$490mil markdown on investments during the 1Q26, its largest since launch, although it also booked US$100mil in realised investment gains over the period.

FS KKR reported realised investment losses of US$195mil, its highest quarterly figure since 2024 and the second largest in its history, Reuters says.

Crescent Capital BDC also posted more than US$12mil of realised losses, its highest quarterly level since 2020.

Industry representatives maintain that listed BDCs remain among the most transparent parts of the private credit market.

Jiri Krol, global head of the Alternative Credit Council, has told Reuters that BDCs continue to play an important role in financing middle-market companies while offering investors standardised reporting on valuations, leverage and portfolio performance.

He argues that this level of transparency exceeds what is typically available from bank balance sheets.

Even so, Reuters’ analysis points to an industry entering a more demanding phase.

As borrowing costs remain elevated, valuations continue to adjust and investors look beyond headline earnings measures, scrutiny of listed private credit funds is likely to intensify over the coming quarters.