May 31, 2025 – Private credit delivered relatively solid performance in the first quarter, reflecting resilient fundamentals amidst trade war-related volatility, although certain risks continue to warrant close attention.
Several key themes have emerged in the asset class as the macroeconomic picture rapidly evolved and trade policy took a dramatic turn into protectionism.
First, on tariff exposure. Generally, private credit loan portfolios primarily consist of first lien loans to American sponsor-backed private companies. In addition, some private credit funds maintain exposure to specialty finance markets, mainly equipment finance, along with other segments of the credit market, including collateralized loan obligations and broadly syndicated loans. With that, the vast majority of these loan portfolios are focused on domestic service-oriented businesses, with the most popular direct lending segments including healthcare, business services, and software. For the most part, the private credit industry is relatively isolated from trade war exposure. The typical Business Development Company (“BDC”, used synonymously with private credit fund) has indicated approximately mid-single digit exposure to the sectors most at risk for tariffs, much of which had not yet impacted the underlying portfolio companies as of the first quarter. Nevertheless, with the liquid private credit market’s focus on defensive positioning at the top of the capital stack, with the average BDC portfolio in 80.6% first lien and 85.4% senior secured loans, industry fundamentals have thus far remained fairly sound.
Second, with respect to competitive dynamics, private credit spreads have stabilized, settling in the range of 500bps to 550bps above the base rate (the Secured Overnight Financing Rate, or SOFR, is at 4.3%). As of the first quarter, the average private credit fund had an underlying portfolio yield of 11.3%. Thus far in the second quarter, some BDCs reported a slight widening of spreads (25bps to 50bps) due to April’s volatility, which caused the window for the public loan market to close for several weeks, forcing some large borrowers to return to the direct lending market post Liberation Day. That said, mergers and acquisitions drive much of the activity in direct lending, and M&A activity remains muted due to trade related uncertainty. Moreover, some private equity M&A activity has been replaced by continuation funds, as PE firms are choosing to hold on to their portfolio companies for longer.
Over the past year, the average portfolio yield in the liquid private credit space declined by 150bps, from 12.8% to 11.3%, consisting of a 100bps decline in the base rate (due to Fed rate cuts) and 50bps of spread tightening (which occurred last year).
Source: Accelerate
The risks behind credit fundamentals remain balanced. Non-accruals refer to loans in which the borrower has stopped making scheduled interest or principal payments, so the lender stops accruing interest income on the loan because collection is uncertain. Non-accruals are a key risk metric in private credit, representing a sign of potential credit deterioration or improvement.
On the positive side, non-accruals declined slightly in the quarter, falling from 2.0% at year end to 1.8% in Q1.
Source: Accelerate
Payment-in-kind (PIK) interest refers to a situation where a borrower pays interest by issuing additional debt or equity instead of paying in cash. While PIK interest allows the borrower to conserve cash, it increases their overall debt burden and adds risk for the lender.
Quarter-over-quarter, PIK income rose 100bps to 7.9%. In contrast to declining non-accruals, rising PIK income may signal weakening credit conditions. That said, many private credit loans incorporate PIK at the time of loan origination to win the business by providing flexibility to the borrower, as opposed to amendment-oriented PIK resulting from declining fundamentals.
Source: Accelerate
The Accelerate Diversified Credit Income Fund (TSX:INCM) holds 20 liquid private credit funds in its portfolio. The quarterly total return of the portfolio of 1.0% was below expectations, a result of net-asset-value (NAV) losses of -1.6% combined with an average distribution of 2.6%.
Blackstone continues to lead the market with its top-tier performance in private credit, and is joined by Ares for its high quality portfolio and consistency. After several punishing quarters in a row, Blackrock’s private credit fund may be finally turning a quarter, displaying a solid total return in Q1. Other strong performers in the first quarter include Bain, MidCap (Apollo), and Morgan Stanley.
In contrast, Cion’s portfolio continues to struggle immensely due to continued problems in a small number of idiosyncratic legacy positions. Oaktree remains in the doghouse, with a private credit fund that has been struggling with losses for several quarters in a row. Palmer Square’s fund exhibited negative performance due to widening spreads in the broadly syndicated loan market, a result of the fund’s higher leverage and more liquid (and marked-to-market) loan portfolio.
Source: Accelerate
Nevertheless, credit performance appeared to be better than the market had expected, as exhibited by the tremendous amount of volatility experienced in the liquid private credit market that started in late March and ramped up significantly into April. On March 27th, the average BDC was trading in line with its NAV. Within just eight trading sessions, private credit discounts had blown out, with the average BDC trading down to a -16.3% discount to NAV. This immense volatility is rare, although it is expected to occur once every five years or so, with BDCs historically trading back to NAV once the market volatility subsides.
One of the most common misconceptions about alternative investments is that private credit is a low volatility asset class. Historically, this myth was driven by non-traded assets that are marked-to-model, rather than marked-to market. A volatility measure is only accurate with daily marks from a liquid asset. Unfortunately, this myth has proliferated, resulting in misleading charts as displayed here:
Obviously, private credit does not have lower volatility (risk) than U.S. core bonds! In addition, it is safe to assume that private credit is riskier than the U.S. high yield market.
Nonetheless, we can accurately assess the volatility of private credit by observing the liquid private credit market, which consists of publicly-traded BDCs. The publicly-traded BDC segment has grown significantly, and now contains representation from nearly every leading private credit manager. Blackstone, Ares, Blue Owl, KKR, Apollo, Oaktree, Carlyle, Goldman Sachs, Morgan Stanley, Golub, Sixth Street, and more – all have listed private credit funds that trade daily on the NYSE or NASDAQ.
Using the Accelerate Liquid Private Credit Index, we can accurately calculate the volatility of private credit.
Before Liberation Day, private credit had a volatility of around 10 (it hit as low as 6 last summer). Since then, vol has surged, recently spiking above 30.
Source: Accelerate
A volatility measure of 10 indicates that 68% of annual returns are expected to fall within ±10% of the average return. While it is true that private credit fund NAVs may exhibit low variability (given they are marked-to-model), private credit funds can trade at discounts or premiums to NAV depending on sentiment, which can dramatically increase realized (and realistic) volatility. During bear markets, NAV discounts are expected to widen and yields are expected to increase, which should be par for the course for leveraged sub-investment grade credit.
While many allocators prefer unlisted BDCs and private assets due to their lack of disclosed mark-to-market volatility (which is understandable as high volatility makes end investors uncomfortable), there are several advantages to liquid private credit that serve as trade-offs compared to their unlisted brethren (many of which have the same underlying loan portfolios). In addition to the convenience of liquidity, the daily mark-to-market provides a somewhat realistic barometer of risks and potential red flags for an investor that they may not be attuned to with private assets. More interestingly, listed BDCs can capitalize on the volatility to create value for fund holders in a way that is not available to holders of unlisted BDCs. Listed BDCs can capitalize on market volatility by issuing shares when they trade above NAV and buying back their shares when they trade below NAV. Both of these actions are accretive to NAV per share (they increase the NAV per share), benefiting listed BDC holders in a way that is unavailable to unlisted BDC holders (of even the same fund).
For example, in the first quarter, Golub Capital (GBDC) issued $38 million of stock (1% of the fund) when its shares traded at a premium to NAV, and subsequently repurchased $35 million of stock when it traded to a NAV discount one month later. These actions create value for fund holders by increasing their NAV per share.
Despite the volatility, private credit remains one of the highest yielding asset classes, with a current average yield of nearly 12%. It is an asset class that can be suitable for many investors, given its attractive attributes, primarily double-digit yields from senior secured floating rate loans. However, allocators need to be realistic with respect to the underlying risk and volatility of the asset class, which can be supported by data. Moreover, the volatility of private credit can present an opportunity. In bear markets, investors can capitalize on NAV discounts by buying interests in private credit funds below 100 cents on the dollar. For example, currently, the median listed BDC currently trades at an -8.5% discount to its NAV (the underlying value of its loans as of March 31, 2025). In addition, this market dislocation can be an opportunity for the private credit fund itself, as it can repurchase shares at a discount, which is accretive to NAV (many BDCs are currently doing this) – a dynamic that is not available to unlisted BDCs.
Ultimately, while volatility has recently spiked and private credit NAV discounts have widened markedly, credit conditions remain better than that implied by the market drawdown. Therefore, the asset class, supported by double-digit yields, may provide an attractive opportunity for income-seeking investors in the current market environment, particularly as secondary trading prices continue to bounce-back after April’s market drubbing.
Each individual merger is assigned a risk rating:
- AA – a merger arbitrage rated ‘AA’ has the highest rating assigned by AlphaRank. The merger has the highest probability of closing.
- A – a merger arbitrage rated ‘A’ differs from the highest-rated mergers only by a small degree. The merger has a very high probability of closing.
- BBB – a merger arbitrage rated ‘BBB’ is of investment grade and has a high probability of closing.
- BB – a merger arbitrage rated ‘BB’ is somewhat speculative in nature and has a greater than 90% probability of closing.
- B – a merger arbitrage rated ‘B’ is speculative in nature and has a greater than 85% probability of closing.
- CCC – a merger arbitrage rated ‘CCC’ is very speculative in nature. The merger is subject to certain conditions that may not be satisfied.
- NR – a merger-rated NR is trading either at a premium to the implied consideration or a discount to the unaffected price.
The AlphaRank merger analytics database is utilized in running the Accelerate Arbitrage Fund (TSX: ARB), which may have positions in some of the securities mentioned.
