Debt from nonbank lenders is less likely to appear on the books of private companies seeking bankruptcy protection in US courts this year after jumping higher in 2023.

After spiking to 4.3% of all private companies seeking bankruptcy protection in US courts in 2023, the share of those companies with a recent private credit loan fell to 2.3% through Sept. 16, 2024, according to S&P Global Market Intelligence data.

In comparison, from 2019 to 2022, 1.7% of US private companies filed for bankruptcy within a few years of tapping the private credit markets.

Bankruptcies represent only a portion of all loan defaults, so they provide a partial picture of the stress facing private companies that have sought loans in the private credit market.

But the low prevalence of nonbank loans among US private companies filing for bankruptcy may also reflect the flexible approach private credit lenders take to distressed situations, said M. Shams Billah, leader of the private credit team at law firm Barnes & Thornburg.

"They're willing to work things out so you never get to bankruptcy," Billah said.

Lagging indicator

The number of US private companies filing for bankruptcy within a few years of a private credit loan spiked to 26 in 2023, more than 3x the 2022 total, according to S&P Global Market Intelligence data. When private company bankruptcy filers are ranked by the size of their private credit loans, seven of the firms with the 10 largest loan totals declared bankruptcy in 2023.

Bankruptcies are a lagging economic indicator, noted Rene Canezin, managing partner at Evolution Credit Partners, an alternative credit manager. Last year's surge had its roots in the 2022 shift into higher interest rates and a more uncertain macroeconomic environment, he said.

For the year to Sept. 16, 10 private companies filed for bankruptcy after borrowing from a nonbank lender, putting the total on track to show an annual decline. But the number is still high compared to recent years.

Canezin said loan defaults, which include bankruptcies and out-of-court restructurings, are normalizing after a long period of low interest rates that had kept defaults at bay.

"Anecdotally, that's what the market is feeling — an increase in default rates, but not really off the charts," he said.

Avoiding bankruptcy

Many private credit funds are operated by alternative asset managers with roots in private equity who have experience guiding companies in financial distress, said Mark Wasden, a senior vice president at Moody's and part of the firm's financial institutions group.

"A lot of the participants in private credit that have this heritage to be able to look at distressed situations, avoid default altogether and simply restructure prior to that being an inevitability. Often, it involves the equity sponsor putting in some additional capital or the direct lender maybe taking a haircut on some of the exposure and trading some of the credit for an equity exposure. [Payment-in-kind] arrangements are a big part of this," Wasden said.

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He said that flexibility on the part of the private credit lenders likely plays a role in relatively low bankruptcy rates. It also means bankruptcy cannot provide a full picture of asset quality in the private credit funds that have captured the attention of institutional investors.

"What I would argue, and our own anecdotal experience suggests, is that there are plenty of distressed exchanges going on in private credit land," Wasden said.