Emerging ‘bifurcation’ of quality in middle market private credit
There has been an uptick in rating downgrades among the weakest middle market private credit issuers in the first quarter of 2024, despite general trend changes heading in a positive direction.
Issuers rated CCC (high) or lower now represent six per cent of credit agency Morningstar DBRS’ portfolio, according to its latest update. That is unchanged from the end of 2023, but up from two per cent at the end of 2022.
“Our credit rating actions in the first quarter of 2024 indicate an emerging bifurcation in middle market private credit rating activity. We continued to observe erosion in credit quality among the weakest issuers, which drove up the portion of issuers rated CCC (high) or lower,” the credit agency said.
However, it also noted that trends towards potential positive credit rating changes are increasing, with changes in a positive direction exceeding those in a negative direction in the first quarter of 2024.
Read more: Moody’s downgrades three direct lending funds
The agency said that downgrades outpaced upgrades by 2.6 times in the first quarter of 2024, which is slightly higher than 2.3 times a year ago. However, this ratio has declined sharply from a high of 5.7 times in the fourth quarter of 2023, despite still being in range of most of last year.
“We have observed a steady improvement in the direction of trend changes and under review (UR) placements. Changes in the positive direction now exceed those in the negative direction, at 60 per cent of the total versus 40 per cent. A year ago, positive actions represented just 20 per cent of the category with negative trend changes dominating at 80 per cent,” the agency said.
Under review placements and trend changes are separate from rating changes, in that they denote issuers where the direction of travel suggests a credit rating change is possible in the future.
Read more: Fitch: Competition in private debt is intensifying
New credit rating actions increased 50 per cent year-on-year in the first quarter of 2024, led by inflow from the consumer products and services sectors.
The agency expects the second quarter of 2024 to show a similar appetite for new credit ratings. The requested volume since the start of the year comprises a balanced mix of US and European lenders.
Discontinuations increased to 4.3 per cent of total credit rating actions in the first quarter, compared with one per cent a year ago, driven mainly by refinancing or payoffs of current facilities, except one case which was due to a sale.
“Higher discontinuation requests indicate a shift in trend from last year, when issuers/lenders were primarily focused on extensions under existing credit terms. However, we are not yet seeing significant increases in acquisition or change-of-control transactions, which would drive a much higher level of loan turnover,” the agency said.
Read more: Credit ratings for SME CLOs forecast to remain stable despite rising insolvencies
