In private direct lending, references to published default rates can vary widely—whether from traditional rating agencies, valuation firms or legal groups. We consider key differences in the very definition of “default” across different providers and the various methodologies used to measure them. The reality is that default can mean different things in different contexts and across different industry participants. We conclude that investors should always inquire: Whose default is it?
To start, investors should recognize a clear distinction between the nature of public and private credit and the various methodologies used to measure credit stress and default across these two areas. (See Exhibit 1)
Rating agencies maintain broad coverage of the syndicated public loan universe, with clear and common criteria for assessing these securities, and provide a consistent, industry-wide view. In contrast, coverage of private credit is less comprehensive, with more limited tracking of these illiquid, non-traded loans and different criteria applied to their credit estimates.
The very distinction between a credit rating and a credit estimate is worth noting. Much of the difference in analyst coverage across public and private credit is due to the opacity of the private lending landscape, where information is less transparent and accessible. In a word, it’s private.
As a result, it’s easier to establish a consensus pool of loans and apply a consistent set of criteria to assess these loans in the public space. In private credit, however, the pool of loans readily available to any one rating agency will vary based on its own loan book and level of access.
The differences extend also to the absence of market pricing for most private loans—an important indicator of credit stress—since these securities are not publicly traded. Instead, valuations on private debt are provided, loan by loan, by the individual lenders themselves, often assessed or corroborated by third-party valuation firms.
Even when a credit estimate is available on a private loan, it must be understood as distinct, in terms of methodology and data availability, from a public issuer rating. All this renders side-by-side comparison of public and private credit default rates not only complicated but potentially misleading.
| Public Credit | Private Credit | |
|---|---|---|
| Rating Agency Coverage | Broad coverage of syndicated loan universe; all rating agencies provide credit “ratings” | Limited tracking of direct lending issuers and credits; some rating agencies provide credit “estimates” |
| Information Access | Information generally accessible on syndicated loans with transparent data | Private loan information that is both opaque and not readily available |
| Loan Pool | More clearly defined market-standard pool of loans for broad analyst engagement | No consensus on or equally accessible pool of loans for analyst measurement |
| Market Pricing | Generally available market pricing on most syndicated loans | No public venue for pricing; select loans marked quarterly by third-party valuation firms |
Source: Golub Capital analysis and LSTA publication: “Why is there a disparity in private credit default rates?” May 15, 2024. The major indexes and ratings agencies use different methodologies and definitions to measure default. S&P Capital includes selective defaults, including PIK conversion or deferred payment, amend to extend, and amortization waivers. Conventional default includes only missed interest or principal payment, distressed exchange, and bankruptcy filing. Different ratings agencies also use different time periods for their default calculations: Fitch, S&P and KBRA calculate their default rates on a trailing 12-month basis, updated monthly, so they reflect the size of the universe 12 months prior; Proskauer and Lincoln consider defaults on a point-in-time quarterly basis.
Even within the private credit space, there is no uniformity in how default is defined or measured.
Across the array of industry participants covering private credit issuers—which includes valuation firms, rating agencies and law firms—each draws from their own unique set of loan documents. As a result, no single source can reliably represent industry-wide credit stress. Further, some coverage analysts (such as Lincoln and Proskauer) include covenant breaches in their definition of default, while others do not. That’s an important distinction. (See Exhibit 2)
Breaching a maintenance covenant, while technically a form of default, is not construed as a conventional measure of default. True default is far more grave; it usually involves a failure to pay principal or interest or company insolvency. Including covenant breaches can skew default rates—especially for smaller firms that are more likely to have such covenants. Larger firms, which tend not to have maintenance covenants, may appear less stressed simply due to this methodological bias.
Finally, other inconsistencies exist beyond the inclusion (or not) of covenant breaches. Some firms may include amendments, amortization waivers, payment-in-kind (PIK) conversions or distressed exchanges. While all of these actions may represent early signs of credit stress, they do not indicate the same degree of stress, and their selective inclusion or exclusion only adds to the disparity in measurement. Again, we must ask: Whose default is it?
| Agency | Universe | Includes Covenant Defaults | Types of “Selective” Defaults Included |
|---|---|---|---|
| Fitch | Provides private ratings on 1,200 middle market loans | No |
|
| S&P | Provides credit estimates on 2,800 borrowers | No |
|
| Proskauer | Tracks 980 senior secured and unitranche loans | Yes |
|
| Lincoln | Tracks 500 middle market direct loans | Yes |
|
| KBRA | Index contains 2,400 companies financed by direct loans | No |
|
* The types of “selective” defaults included do not meet the definition of “conventional” defaults.
Source: Golub Capital analysis and LSTA “Why is there a disparity in private credit default rates?” May 15, 2024.
What does this mean for investors seeking to understand the level of true default risk in private credit? As shown in Exhibit 3, the inclusion of selective measures of default can significantly impact their perception of potential risk. Both metrics are provided by the same rating agency, but two things stand out.
First, selective defaults tend to be significantly higher than the conventional payment default because they include more and earlier indicators of stress. Second, the selective default line is more sensitive, rising earlier and more sharply than conventional measures of default.
This suggests that selective default metrics can be a useful leading indicator of future stress. However, they can also amplify perceived risk. While they offer early detection value, that signal must be interpreted in a broader, more informed context.
1. Golub Capital Analysis and S&P Capital; Selective defaults for S&P Capital include PIK conversion or deferred payment, amend to extend, and amortization waivers. Conventional default includes only missed interest or principal payment, distressed exchange and bankruptcy filing.
Consider three distinct measures of selective default rates from Fitch, S&P and Lincoln International, all measured at the end of Q3 2024.
Because each firm has its own distinct—possibly overlapping, but not identical—pool of loans and applies its own definition of selectivity in determining default, we’re left with highly disparate measures of default in the private credit space.
Fitch calculates its default rate based on a pool of approximately 1,200 loans. It’s an annualized figure, based on nine months of available data, marking it as a relatively new data source. S&P uses a broader base of around 2,800 loans and applies its own selective default methodology, which is similar to but not fully aligned with Fitch’s approach.
Meanwhile, Lincoln, which reviews about 500 direct loans as part of its valuation work, employs a distinct methodology centered on covenant defaults.
The result is more confusion than clarity, with default rates sometimes varying substantially across different organizations. The only way to navigate through this relativity in the representation of private market credit stress is to understand the distinct methodologies applied in each case.
7%
Based on 1,200 loans; 9 months annualized; uncured payment default and distressed exchanges
Fitch
(Includes Selective Defaults)2
4.3%
Based on 2,800 loans; TTM; includes selective default metrics
S&P
(Includes Selective Defaults)3
2.2%
Based on ~500 loans; includes covenant defaults; loans defaulted in current quarter plus those uncured from previous quarters
Lincoln
(Includes Covenant Breaches)4
We pursue the disparities of default measurement beyond public vs. private and private vs. private contexts, down to the manager level. Here, too, we find a wide range of selectivity and varying degrees of strictness in the application of different definitions of default.
These differences are often buried in the footnotes of credit manager presentations. Some rely on a simple payment default metric, which is a conventional measure but a relatively narrow approach. Others expand their definition to include certain write-downs associated with distressed exchanges. Some adopt even more conservative criteria, including persistent ratings underperformance or PIK conversion. (See Exhibit 5)
These discrepancies can complicate due diligence and make manager-to-manager comparisons difficult. Our advice to investors remains the same. Always ask: Whose default is it?
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