BDCs Face Rising Credit-Quality Pressure Into 2026, Fitch Says
TL;DR
Fitch Ratings warns BDCs face rising credit-quality pressure into 2026, with increased PIK volumes and tighter spreads. Investor anxiety over portfolio quality and defaults is driving declines in BDC shares and bonds.
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Publicly-traded business development companies can expect growing pressure next year, with payment-in-kind volume predicted to rise as spreads tighten further, according to a Fitch Ratings report on Wednesday.
Shares of BDCs, which package private loans into funds and often trade publicly, have declined in recent months as investor anxiety over the quality of their portfolios is rising following recent defaults. Earlier this month, Fitch stamped a “deteriorating” outlook on BDCs, citing prolonged asset quality pressures from the challenging economic backdrop.
BDC bonds have also been sliding in recent weeks, which Fitch says is another sign of investors’ heightened focus on portfolio credit performance heading into the new year.
Participants surveyed by Fitch, which included fixed income investors, bankers and BDCs, cited limited access to deals as a key driver of the dispersion in BDC performance. Players with scale have a strong advantage when it comes to origination opportunities and diversification, the report said.
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Declining interest rates, another focus for investors, will also fuel additional dividend cuts in the coming quarters, Fitch said. As dividends suffer, BDCs’ leverage and liquidity levels are likely to follow suit – a dynamic that will test the vehicles’ tolerance for mechanisms like PIK.
Payment-in-kind debt allows borrowers to push back payments until the debt itself has to be repaid. But the pile of this expensive debt has been swelling, raising concern that private credit funds are using PIK to mask a deterioration in loan quality.
Nearly half of the respondents to Fitch’s survey expect PIK to rise in 2026. However, participants also voiced the importance of differentiation between “good” and “bad PIK.” While “good PIK”, or PIK structured at deal conception, can boost returns and offer flexibility, PIK added during a restructuring or amendment could “lead to an eventual increase in non-accruals and losses,” the Fitch report said.
Although lower rates could alleviate borrowers’ need for this kind of flexibility, Fitch contends that “PIK income will remain elevated as sponsors have become used to the optionality.”