Headline measures of stress in private credit portfolios may be overstating the extent of credit deterioration across business development companies (BDCs), according to new analysis by Moody’s Analytics.
Moody’s said that investors often look at the proportion of loans marked below par as a simple indicator of stress in private credit portfolios, but analysis of more than 6,000 investments across 34 listed BDCs suggests that below-par marks do not always reflect worsening borrower credit quality.
Instead, a significant share of discounted positions appear to be linked to the price at which loans entered portfolios in the first place, rather than a subsequent deterioration in value.
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The analysis found that, for loans entering portfolios at a discount, around three quarters of the observed deviation from par was associated with entry basis rather than later valuation movement. This means that a loan marked below par may not necessarily be signalling fresh stress. In some cases, the discount may reflect original issue discounts, upfront fee structures, or illiquidity when the loan was made or acquired.
For example, a loan with a face value of 100, recorded at a cost of 95 and currently valued at 92, would appear to be trading at an eight per cent discount to par. However, five percentage points of that discount were already embedded when the loan entered the portfolio, leaving only three percentage points attributable to subsequent valuation movement.
“The findings suggest that investors may gain more insight from monitoring movements within the near-par segment than from focusing solely on the deepest discount bucket,” Moody’s said in the report.
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The report said the findings show that headline discount levels may overstate the amount of deterioration occurring after origination.
“From a private credit perspective, this is important because investors often use the share of assets marked below par as a shorthand for portfolio stress,” Moody’s said. “The evidence here suggests that such a shorthand can be misleading unless entry pricing is taken into account.”
