In third-quarter 2024, business development companies and interval funds recorded the first decline in loans making payment in kind (PIK) payments in their asset portfolios for over a year.

This came after a steady rise of PIK-paying loans within BDC portfolios from second-quarter 2023 through second-quarter 2024 caught investor attention.

PIK can indicate credit stress. When a borrower opts to preserve cash flow by making PIK payments, it may signal an inability to meet cash interest demands. However, in recent years, some borrowers have also chosen financing that allows PIK payments up front as a portion of interest payments, and this is seen in recurring revenue loan structures.

The proliferation of PIK loans had been increasing since late 2023 as borrowers faced higher-for-longer interest rates that pressured cash flows. The recent pause appears to have coincided with the U.S. Federal Reserve cutting the federal funds rate, with the fair value of loans within BDC portfolios making PIK payments falling slightly to $38.8 billion in third-quarter 2024 from just under $40.3 billion in the second quarter.

However, the recent U.S. announcement of a wave of substantial additional tariffs, that were far broader and more severe than expected, will likely weigh on global credit conditions. Given the uncertainty regarding these macroeconomic headwinds, it is unclear if the decline in PIK payments will reflect a lull, or the start of a new downward trend.

While the total amount of loans making PIK payments declined modestly in aggregate, this drop was more pronounced as a percentage of BDCs' loan assets. With the fair value of total loan assets rising by almost 10% in the third quarter, the share of these loans with PIKs fell to 10.2% from 11.6%. S&P Global Ratings' estimates of the amount and share of loans making PIK payments are based on available disclosures from more than 165 BDCs, including both rated and unrated BDCs and interval funds. They are more likely to understate than overstate the actual share of loans making PIK payments.

Chart 1

Among the 16 publicly-rated BDCs, PIK income declined as a share of gross investment income for six players in the third quarter, and was largely unchanged for three others.

Most PIK income continues to be associated with performing investments that were originated with a PIK feature, with only a small percentage of investments amending cash interest to PIK. However, we have also seen several general partners (GPs) that have the ability to identify and amend their potentially underperforming investments by temporarily converting cash interest to PIK. We view amended PIK investments as an indicator of stressed borrowers. In 2025, we expect overall PIK income will rise as a share of gross investment income, given it is predominantly fixed rate. We also see reduced base rates leading to lower net investment income (denominator effect), unless this is offset by growth in non-PIK investments.

Chart 2

Nontraded BDCs Lead Asset Growth

The private credit market is growing, and so are BDC assets. BDCs were created by an act of U.S. Congress in 1980 to provide capital to small and midsize borrowers. To meet this mandate, BDCs are substantial suppliers of funding for private credit, which comprise most assets they hold.

Traditionally, BDCs have been structured as closed-end funds that trade publicly on an exchange, but demand for new traded BDCs has paled in comparison to the popularity of other structures. These include nontraded BDCs, such as private BDCs and perpetually nontraded BDCs. Interval funds, which are similar to nontraded BDCs in that they are nontraded closed-end funds that offer periodic redemptions for a set percentage of outstanding shares, have also rapidly grown in recent years. Over the past three years, the fair value of nontraded BDC assets has expanded near 229% to $237.2 billion, while the interval fund assets that we track have increased 195% to $60.5 billion. By contrast, publicly traded BDC assets have shown only limited growth over this period, up 11% to $155.4 billion.

This continued into third-quarter 2024, when the assets of nontraded BDCs grew 56% (up $85 billion), interval funds nearly 60% (up $22.7 billion), and traded BDCs 6% (up $8.6 billion), over the preceding four quarters, respectively.

Chart 3

The combined pool of assets held by BDCs and interval funds rose by 9% quarter on quarter as of Sept. 30, 2024, to $453 billion. While the number of BDCs and interval funds remains high, we publicly rate 16 BDCs. These include many of the larger entities in this sector, with rated BDCs holding about $212 billion in assets under management, or 47% of total BDC assets in third-quarter 2024.

Within these portfolios, the most pronounced asset growth came from private credit loans, up 10% to $262 billion, while broadly syndicated loans (BSLs) rose 7% to $119 billion. Private credit accounts for the majority of BDC and interval fund assets (at 58%), while private credit and BSLs together account for about 84% of assets. Private credit loans tend to be from small-to-midsize borrowers, while BSLs are generally from borrowers that are larger and can benefit from the scale of the syndicated loan market.

Chart 4

However, an important distinction between private credit and BSLs is that private credit is less liquid, and largely does not trade in a secondary market. BSLs are relatively more liquid, and nontraded BDCs tend to hold a larger share of BSLs in their portfolios than publicly traded BDCs.

This could reflect the need for relatively more liquidity among nontraded BDCs and interval funds. Publicly traded BDCs are set up as closed-end funds, and while this allows more liquidity flexibility for those that are traded, it also may result in the BDC's share price diverging from the net asset value. By contrast, nontraded BDCs and interval funds must manage liquidity to meet periodic investor redemptions that are capped at 5% of net asset value per quarter.

Chart 5

BDC Loans Are Diverse By Borrower, Less So By Value

Loans held by BDCs reflect a large pool of more than 6,000 diverse borrowers, which is close to double the number of speculative-grade rated borrowers globally. This multitude of borrowers can help enable diversification between BDC portfolios and limit overlap.

Almost 80% of these borrowers have loans held by a less than five BDCs, versus just over 5% with loans held by more than 10 BDCs, and less than 0.3% with loans held by more than 30 BDCs.

Chart 6

However, the borrowers with loans held by the greatest number of BDCs will tend to be among the largest, and account for a greater share of assets than the less widely held borrowers. For instance, the 21% of borrowers with loans held by five or more BDCs account for about 61% of BDC loan assets at fair value. Even though the pool of BDC assets contains over 6,000 borrowers, the roughly 1,000 that are most widely held are likely to have a greater effect on performance.

However, Exposure To The Largest Borrowers Has Declined

After several multi-billion-dollar, headline private credit deals in recent years, BDCs' concentration in the largest deals may be perceived as increasing. However, we found that BDCs' exposure to their 10 largest borrowers declined slightly over the past year.

Private credit has extended ever-larger sums to borrowers through club deals, including more than $3 billion for Anaplan in 2024, $4.6 billion for Zendesk in 2022, and $2.8 billion for Guidehouse in 2021. These remain among the largest private credit loan positions held by BDCs in third-quarter 2024. However, in third-quarter 2023, the 10 largest private credit borrower positions amounted to $16.6 billion in BDC assets, versus $16.5 billion in third-quarter 2024. BDCs' exposure to their 10 largest borrower positions has also declined as a share of total private credit assets, to 6.3% from 8.6%, over this period.

Chart 7

BDCs' loan portfolios include BSLs and private credit. Between our ratings on issuers of BSLs, and our credit estimates of middle-market borrowers with loans held within collateralized loan obligations (CLOs), we have a view into the credit quality of a considerable portion of these assets. Almost half of the borrowers with loans held by BDCs are either issuers of BSLs (and are likely rated) or are an entity for which we have a credit estimate. By fair value, the portion of the assets that are either BSLs or credit estimates is larger, at near 69%.

Chart 8

Debt Maturing In 2025 And 2026 Has Declined

Financing conditions were broadly favorable for leveraged borrowers in second-half 2024, meaning they were widely able to lower funding costs and extend maturities. The increase in funding options for borrowers was mirrored in the spread compression in BSL markets, with spreads in the private credit market typically tightening to about the secured overnight financing rate (SOFR) plus 450-500 points for upper-middle-market direct lenders. We do not expect credit spreads to widen significantly given rising competition.

Repricings rolled through the BSL and private credit markets and reached a new record for the former. Strong issuance, tighter spreads, and lower interest rates all supported this repricing activity. We believe that direct lenders' ability to write larger checks will allow them to effectively compete with the BSL market. Flush with cash and significant fundraising due to continued demand, especially in the high-net-worth channel, there will likely be an urgency to deploy capital in 2025, especially for nontraded BDCs. This could influence underwriting standards, and in turn hurt asset quality.

Strong issuance also supported the relative decrease in the amount of debt due in 2025 and 2026, as more new issuances maturing in 2029 or 2030 were added to the asset mix. BDCs issued more CLOs as an alternative source of funding, given the tightening liability spreads for this asset class and the funding term that is matched to the asset's maturity. The amount of private credit held by BDCs set to mature in 2025 declined 44% to $11.1 billion during third-quarter 2024, and the amount set to mature in 2026 fell 16% to $30.1 billion (see chart 9). These reductions likely reflect a combination of amortization of loans with a near-term maturity, as well as refinancings. The year with the largest maturities coming due remains 2028, both within the rated leveraged finance market and the loan portfolios of BDCs.

Chart 9

The flow of assets into BDCs, and new nontraded BDCs and interval funds attracting investments, have been supporting favorable financing conditions for private credit borrowers. In turn, refinancings, repricings, and lower funding costs have helped borrowers find better footing. However, we think the recent announcement of tariffs from the U.S. represents a material escalation in trade tensions. These may lead to slower GDP growth, rising unemployment, and higher inflation, and this could create new headwinds for issuers already struggling in the current economic environment.

S&P Global Ratings believes there is a high degree of unpredictability around policy implementation by the U.S. administration and possible responses--specifically with regard to tariffs--and the potential effect on economies, supply chains, and credit conditions around the world. As a result, our baseline forecasts carry a significant amount of uncertainty. As situations evolve, we will gauge the macro and credit materiality of potential and actual policy shifts and reassess our guidance accordingly (see our research here: spglobal.com/ratings).

Related Research

• CreditWeek: How Much Will Credit Conditions Deteriorate As Global Trade Tensions Heat Up?, April 3, 2025
• Default, Transition, and Recovery: The U.S. Leveraged Loan Default Rate Is Set To Rise To 1.6% Through December 2025, March 10, 2025
• Private Credit And Middle-Market CLO Quarterly: Waiting For The Sun, Jan. 24, 2025