Morningstar DBRS Warns of Deteriorating Private Credit Quality Amid Rising Downgrades

Private Credit Quality Continues to Deteriorate in 2024

According to Morningstar DBRS, a rating agency, the proportion of downgrades in private credit has reached a new high in February. The number of downgrades was 3.3 times the number of upgrades this month, up from 2.4 times a year ago. This trend suggests that the quality of private credit is worsening.

Negative Outlook for 2026

The outlook for 2026 remains negative due to margin compression in various sectors and rising debt levels. Michael Dimler, senior vice president for private credit ratings, notes that the increasing number of downgrades is a concern. Morningstar DBRS provides private credit ratings for approximately 450 middle market borrowers in North America and Europe, with an average revenue of $250 million.

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Risk Assessment

As private credit volumes grow, markets are trying to assess default and liquidity risk to lenders, including large private equity firms. However, private credit lenders do not usually disclose data that allows investors to understand where the main problems could happen. In contrast, loans in public markets or bank balance sheets are easier to analyze and disclose more information about potential defaults and risk.

Portfolio Quality

The average quality of the portfolio of companies rated by Morningstar DBRS has worsened. The percentage of companies seen as safer credits, with higher ratings such as B, has fallen from 41% to 39% over the last 12 months. Riskier companies, classified between the ratings CCC and C, now represent 16% of the total, up from 12% a year ago. Defaults have also been rising, reaching 4% in February, above 3.2% in the prior year.

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AI Disruption Risk

Morningstar DBRS is attentive to the disruption risk to software companies by artificial intelligence use. However, so far, the effect on the ratings has not been significant among the companies rated. Borrowing costs are already rising, and some software companies are opting to delay debt deals. The main criteria for identifying companies that could be most affected are customer relationships and the costliness of switching software for clients.