In KBRA’s Q2 middle market (MM) surveillance compendium, KBRA examined how revenue and EBITDA growth have cushioned the blow of higher interest costs among private credit borrowers. The analysis is especially interesting due to the dearth of observed defaults so far, relative to KBRA's expectations.

In this report, KBRA takes a deep dive into three-year revenue, EBITDA, and interest coverage ratio (ICR) trends for 1,067 unique MM names that KBRA has assessed in first-half (1H) 2024. In addition, KBRA also provides new data related to the surveillance of 396 MM corporate credit assessments and the 171 new assessments assigned in Q2 2024. KBRA has performed over 3,500 corporate credit assessments over the past two years, and the data related to these assessments continue to provide unique insight into the otherwise opaque direct lending landscape. KBRA monitors these credit assessments as part of the surveillance of hundreds of KBRA-rated private credit feeder notes, 30 business development corporations (BDC), dozens of private credit NAV/leverage facility transactions, as well as collateralized loan obligations (CLO).

Key Takeaways

• Strong revenue and EBITDA growth among many private credit borrowers is helping to cushion the effect of higher interest costs. Across 1,067 unique borrowers, KBRA found median annual revenue growth of 20% during the three most recent periods, and even stronger median EBITDA growth of 46%. Notably, these trends are fairly consistent across all quartiles of company size—from the largest to the smallest companies in our portfolio of year-to-date assessments.

• KBRA examined the distribution of changes in revenue, EBITDA, and interest coverage across all companies, as we recognize that a focus on averages can mask important trends in the underlying portfolio companies. One data observation identified was that 21% of the companies migrated from below 1.0x coverage to above 1.0x interest coverage during the recent two years of rate hikes and inflationary headwinds, while just 12% of companies moved in the opposite direction.

• Some companies are experiencing sustained pressure, evidenced by the fact that 25% of all companies assessed in 2024 have an ICR below 1.0x in the most recent period and 56% of all companies had some weakening of their ICR during the periods observed.

• KBRA has observed, anecdotally, that many relatively stronger companies are demanding and receiving concessions on spreads that have served to further reduce the blow of higher base rates.

• While KBRA observes weakening credit quality for some companies, defaults in Q2 2024 remain muted with only five defaults. Downward credit migration is also more tempered, with 14% of the surveillance obligors receiving a lower score in Q2 versus 21% in Q1.

• Similar to observations in KBRA’s Q1 compendium, the Software sector’s relative resilience is evidenced by its smaller relative percentage of downward assessment actions despite representing a slightly outsized proportion of Q2’s surveillance portfolio. There were also more upgrades than downgrades of assessments that began as ccc+ scores in both quarters.

• KBRA continues to believe its portfolio of ratings backed by MM private credit collateral will not experience significant credit migration. Further, private equity returns (which are absorbing the losses from the ongoing downward pressure on valuations, particularly from 2020-2022 vintages) will remain the most vulnerable to the pressures being felt by underlying borrowers. As mentioned in prior reports, we expect to see increasing divergence of performance amongst private sponsors in future years.

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