In KBRA’s Q3 middle market (MM) surveillance compendium, we examine how revenue and profitability growth are continuing to help an increasing population of borrowers strengthen their financial position, despite higher interest costs. From the early read of the data, we aim to examine how private credit borrowers might be positioned as interest rates decline in coming months.

In KBRA’s view, while there are exceptions, we conclude that most of our portfolio of sponsored MM borrowers have emerged through the peak of rates and are strengthening their financial footing. We found that 75% of assessed obligors have interest coverage ratios (ICR) above 1.0x, and with each passing quarter, that percentage has grown. With the Fed set to continue lowering rates, we postulate that many of the metrics used to gauge the overall health of the private credit direct lending industry will continue to trend upward from here.

In this issue of the compendium, we draw insights from the financial metrics of 1,384 unique MM corporate obligors assessed through third-quarter 2024 (Q3 2024 YTD). We also provide new data related to the 274 surveillance assessments and the 116 new assessments conducted in Q3 2024.

Key Takeaways

• The effects of a slowing economy are showing in the data. Revenue growth rates for borrowers assessed in Q3, at the median, were lower than any other quarter. While lower top line growth give us some pause, largely all other credit metrics appear to be trending in a positive direction. Based on the data, it is beginning to appear, that overall, KBRA’s portfolio of private credit assessment obligors may have made it through the worst of elevated rates on solid ground.
• At the median, obligors’ profitability margins are expanding, which is starting to have a positive impact on ICRs and leverage. Companies assessed in Q3 had the lowest percentage of declining ICRs. Further, across the entire population of businesses with positive EBITDA, leverage has declined at the median over the last three periods.
• Peak interest expense is starting to show in the data, as Q3 assessments saw less than one-half the increase in interest payments compared to the companies we assessed in the prior two quarters. Falling base rates should accelerate this trend (as shown in an analysis where we assumed a 3% base rate) where the 380 borrowers could save around $7 billion in interest expense.
• Assuming a recession is not lurking, and recent economic data only suggests some slowing in the rate of growth, we expect a handful of financial metrics to be at, or near, their trough levels. But as rates fall, we anticipate positive improvements. These metrics include, but are not limited to, non-accruals as a percent of cost in KBRA’s BDC rated universe; the ratio of net downgrades to upgrades in the assessment pool; and KBRA DLD’s* default watch list. As an early indicator, the count of defaults, as tracked by KBRA DLD, has already started to improve.
• While KBRA observed weakening credit quality for some companies, there were no payment defaults observed in our existing portfolio in Q3. Downward credit migration picked up, with 19% of the surveillance obligors receiving a lower score in Q3 versus Q2’s 14%, but still lower than Q1’s 21%. The upgrade-to-downgrade ratio also hit its lowest point of 0.4x in Q3, meaning for every downgrade there were 0.4 upgrades.

^{* KBRA DLD is a division of KBRA Analytics.}

Click here to view the report.

Related Publications

• Private Credit: Pulling Rank and the Game of Senior Preferreds in LMEs
• Private Credit: Rate Cuts Will Help Most but Not All Borrowers
• Private Credit: Khoros’ Potential Default Sprinkled Across Private Credit
• Private Credit: Q2 2024 Middle Market Borrower Surveillance Compendium–EBITDA to the Rescue
• Private Credit: Impact of Pluralsight’s Potential Restructuring Will Be Widely Dispersed and No Effect on Ratings Expected
• Private Credit: First-Quarter 2024 Middle Market Borrower Surveillance Compendium
• Private Credit: 12% Is Here–First Look at Interest Coverage and Liquidity for Middle Market Borrowers by Sector
• Private Credit: 2024 Maturity Wall Is a Myth
• KBRA Insight on Private Credit: Middle Market Rate Stress?Another 50 Basis Points?
• Private Credit: 12% Is Not Affordable for Many Borrowers
• Private Credit: Well Positioned to Navigate the Looming Storm

About KBRA

KBRA is a full-service credit rating agency registered in the U.S., the EU, and the UK, and is designated to provide structured finance ratings in Canada. KBRA’s ratings can be used by investors for regulatory capital purposes in multiple jurisdictions.

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