PitchBook’s Lukatsky on Where Cracks Are Appearing in Private Credit

For many years, private credit boomed, and institutional investors rode those solid returns. But just as fund companies began pitching private credit to individual investors, clouds rolled in, partly thanks to concerns about artificial intelligence’s negative impact on software companies, which are big borrowers. In recent months, individual investors have been clamoring to exit private credit funds amid the headlines about performance.

To assess the state of play in private credit and the bank loan market, we spoke with Marina Lukatsky, global head of credit and US private equity research at PitchBook. She leads the site’s coverage of US and European leveraged loan, high-yield bond, and private credit markets. With the recent release of her team’s latest report on credit quality, Lukatsky explained where PitchBook’s research is finding stress in the private credit market, what debt holders are doing with the value of their loans, and why they are keeping a close watch on 2028. This interview has been edited for clarity and length.

Tom Lauricella: Let’s start with a broad brush. What are we seeing in terms of credit quality in the private credit and bank loan markets?

Marina Lukatsky: Our data shows that cracks are starting to appear, stress is increasing, and the number of companies under some pressure within the BDC [business development company] universe is growing faster than the number of companies overall. Now, it’s not an explosion of stress; it’s creeping higher. But it does show that there’s more pressure.

Lauricella: This has gotten a lot of attention because of the stress reported among software companies. Is that where you’re seeing the cracks, or is it broader?

Lukatsky: It’s broader. Whether you’re talking about the broadly syndicated loan (BSL) universe or private credit, software is the largest industry. But within the liquid markets, there’s been a big gap between the performance of software and non-software loans. When we looked at borrowers in private credit, there were more pressured borrowers in the services sector than in software at the end of last year.

We should be clear that institutional inflows still eclipse retail outflows. But the upheaval we are experiencing definitely impacted the supply/demand balance in the market. Lenders heavily dependent on retail are retrenching, which impacts the demand for paper [loan agreements]. Funds facing severe redemption requests are slowing their deployment [allocation of capital to specific loans], which impacts demand for paper, which influences the balance between demand and supply.

That is changing the dynamic we’ve had all through last year, where the borrower was in the driver’s seat. That had translated into very tight spreads, looser documentation, and terms very favorable to borrowers. Right now, we’re seeing a rebalancing. Lenders have more power in this kind of equilibrium. They’re becoming more selective, and spreads are widening a bit. When you layer in sectors like software, it becomes even harder to get those deals done.

Lauricella: Are we seeing a falloff in lending in this environment?

Lukatsky: Second-quarter numbers are considerably down from the first, and there are multiple factors behind that. One of the key factors is that overall leveraged buyout [LBO] deal-making slowed. When private equity sponsors are doing fewer buyouts, they also need less financing, so there’s a sharp decrease in private equity deal-making. This resulted in a sharp decrease in lending needed across both the broadly syndicated market and direct lending.

Lauricella: When it comes to the credit quality question, industry executives keep saying this is just a media hype story, and that default rates are not at all significant. But others will point to different signs of stress, including rising use of PIK interest. Can you explain what PIK interest is, why it would matter, and what do you guys see in your research?

Lukatsky: PIK stands for “paid in kind.” It means the company is not paying cash interest; instead, the interest gets added to the principal. So if your interest is $10, you don’t pay me the $10; the $10 is added to your principal, and when your debt matures, it will be paid. Not all PIK is bad—like if a company is in the growth stage and needs to conserve cash for an acquisition. Bad PIK is when a company has to do it because it can’t just pay in cash, when it’s clearly underperforming.

Lauricella: Are we seeing more bad PIK?

Lukatsky: For our research, we look at a number of factors. We look at shares of the market, and our data shows that the percentage of loans with PIK is relatively stable year over year. So that’s positive. However, the fair value of those PIK holdings is decreasing, and a lot of those companies are in the software sector.

And we look not just at PIK in isolation, but also PIC [paid-in-capital], plus other credit events, such as changes in coupons, maturity extensions, fair values—a combination of indicators that together tell a more cohesive story. That story is that more companies are facing some pressure. They’re not in distress yet and not in default, but there’s credit pressure on those borrowers, which indicates that the risk is increasing. So it’s not one specific factor; it’s creeping up across the board.

Lauricella: You’re talking about marking down the value of some of these loans. How significant are these markdowns, and how does this compare to the past?

Lukatsky: We see software now in the 86 cents on the dollar area in the BSL market. In the private universe, for software, it’s higher than that. These markdowns are not as drastic as in the liquid market, but they’re more significant than we’ve seen in prior quarters.

Lauricella: What other topics are you keeping an eye on?

Lukatsky: The maturity wall is something we look at very closely. There’s about $40 billion of software loans that will mature in 2028. The important thing is that a very significant portion of that 2028 wall is lower-rated companies—those rated B-minus or lower. More than 50% of the wall falls into that riskier part of the market.

These are companies that are already highly leveraged. We are in a higher-for-longer rate environment, so they have to pay significant cash as interest expenses. There’s pressure there, and the appetite for B-minus is not where it was last year. Lenders are less willing to refinance those companies, especially if they’re from software.

Lauricella: These loans were given out when interest rates were zero, basically.

Lukatsky: Exactly. In 2021, rates were zero. Now rates have increased significantly, and companies that are already lower-rated have a heavier debt burden. The risk is that lenders will not be willing to refinance a company’s debt, or they’ll be willing to refinance at a coupon that’s not acceptable to the borrower. In both scenarios, the borrower needs to decide: “What am I going to do with this debt coming due that I cannot refinance?”

Lauricella: So is there a potential for either a wave of defaults or companies being sold?

Lukatsky: Yes, exactly. They will potentially try to amend to extend, where essentially a lender agrees to extend the maturity in exchange for a higher coupon on the debt. A private sponsor could put in more equity and pay down some of that debt, limiting the risk to the lender. Borrowers can look at a different market. If you’ve got a syndicated loan, private credit lenders might agree to refinance. But again, the question is: At what terms? If the coupon is so high that you can’t possibly pay it, then you’re back to a restructuring or default scenario.

Lauricella: Let’s sum things up. At a high level, what do investors need to know about what we’re seeing in the private credit and the bank syndicated loan markets?

Lukatsky: The key theme for both markets is bifurcation. The market is split into haves and have-nots, and software is have-nots right now. Lenders across the board are repricing risk. They’re really looking at every borrower with the lens of: “Are they going to be hurt by AI, or are they going to benefit from AI? Are they in front of it, or are they lagging?” Because at the end of the day, credit is credit. Whether it’s syndicated or in a direct lending situation, the underwriting process is very similar, where the lender is evaluating the borrower’s creditworthiness.