According to Bloomberg Report
The International Monetary Fund (IMF) issued a warning in a report released last week, indicating that by the end of 2024, over 40% of private credit borrowers will have negative free cash flow, significantly higher than around 25% at the end of 2021. Bloomberg points out that this phenomenon reflects the deteriorating financial conditions of borrowing companies and poses significant risks: Borrowers with insufficient cash flow face a heightened risk of default, particularly against the backdrop of current trade wars raising fears of economic stagnation.
Credit Vulnerability May Impact the Banking Sector
The report continues to highlight that the current scale of the private credit industry has reached $1.6 trillion, and with the industry’s vulnerabilities being exposed, banks may also face the risk of being impacted by cascading shocks. Currently, banks have an exposure to private credit exceeding $500 billion, which these funds are used by asset management companies to provide more loans to clients. The IMF report states: “The risks of earnings erosion and cash flow issues have increased, and certain industries, such as healthcare and software, face particular risks.” The report further reveals that even before the tariff issues escalated, nearly half of the borrowers had negative free operating cash flow, leading them to rely heavily on Payment-in-Kind (PIK) terms and amend-and-extend restructuring arrangements.
Note: Payment-in-Kind (PIK) terms are a financial arrangement that allows borrowers to pay interest or principal in non-cash form, typically by issuing additional debt securities or increasing the principal balance of existing loans instead of cash payments. This approach allows borrowers to meet their debt obligations without utilizing cash flow in the short term, but it increases future debt burdens, as deferred interest accumulates and is added to the principal, resulting in an enlarged total debt size.
The report emphasizes that private equity firms’ reliance on PIK notes is particularly notable; according to data compiled by Bloomberg, in the fourth quarter of 2024, over a quarter of net investment income will come from delayed interest, an increase of approximately nine percentage points from the previous year. In this regard, Elad Shraga, Chief Investment Officer of Signal Capital Partners, stated:
“As financial volatility increases and uncertainty spreads, the timeline for private equity (PE) exits will be delayed, in some cases significantly, hence the sponsor-led credit market may face greater pressure.”
Emerging Issues with Non-Bank Loans
Simultaneously, potential issues with non-bank lending institutions in the U.S. are becoming increasingly apparent. Bloomberg cited a report released by government regulatory agencies last month indicating that in 2024, nearly 21% of non-bank loans have been classified as bad loans, signifying uncertainty in repayments. However, to prevent the turbulence in shadow banking from impacting the traditional banking system, the Financial Stability Board has planned to release policy recommendations regarding leverage usage in July 2025 to curb associated risks.
Additionally, Claire Madden, Managing Partner of Connection Capital, believes that the crisis is not insurmountable. She stated: “Over-leveraged companies do face risks during significant economic shocks, but if direct lending is initially designed reasonably and moderately, borrowers should be able to withstand market fluctuations.” She emphasized: “During periods of stress, private credit institutions can become supportive partners, helping borrowers strive for survival opportunities.”
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