Private credit faces mounting stress as Moody's downgrades KKR fund to junk
FSK's 5.5% non-accrual rate and Blackstone's record $1.7B withdrawals raise sector-wide concerns
Moody's Investors Service delivered a stark warning to the $2 trillion private credit market this week, downgrading FS KKR Capital Corp to junk status as rising loan defaults and investor withdrawals signal intensifying stress across the sector.
The rating agency cut FS KKR from Baa3 to Ba1, one level into speculative grade, citing "ongoing asset quality challenges" that have eroded profitability and portfolio value. The fund's non-accrual rate — the percentage of loans where borrowers have stopped making payments — reached 5.5% of total investments by December 31, 2025, compared with a 0.4% median for comparable funds.
The downgrade marks a rare blow for a sector that has enjoyed explosive growth over the past decade, attracting more than $2 trillion in assets from investors seeking higher yields in a low-rate environment. But cracks are now appearing as default rates climb and liquidity strains emerge.
Blackstone's flagship private credit fund, BCRED, experienced its largest quarterly outflow on record, with investors seeking to withdraw $1.7 billion in the first quarter of 2026. Redemption requests hit 7.9% of the fund's shares, well above the standard 5% quarterly limit. Blackstone responded by increasing its repurchase offer to 7% and investing $400 million of its own capital to cover the remaining 0.9% of withdrawal demands.
The firm maintained that the move reflected its tender offer structure rather than liquidity constraints, noting BCRED held more than $8 billion in available liquidity at year-end and attracted nearly $2 billion in new subscriptions during the quarter. Yet the scramble to meet redemption demands underscores growing investor anxiety.
Competitors including Apollo Global Management and Blue Owl Capital have also imposed restrictions on investor withdrawals in recent weeks, according to industry reports. FS KKR's shares have fallen more than 50% over the past year and currently trade at $10.38, a steep discount to peers like Ares Capital Corporation, which has a market capitalization of $12.9 billion compared to FS KKR's $2.8 billion.
Morgan Stanley analysts warned in a mid-March note that default rates in direct lending markets could reach 8%, levels last seen during the pandemic, as artificial intelligence disruption weighs on software companies that make up roughly 26% of business development company portfolios. Software borrowers exhibit some of the weakest credit metrics, with elevated leverage and low interest coverage ratios.
A wave of debt maturities looms on the horizon. Approximately 11% of software loans in direct lending portfolios come due in 2027, with another 20% maturing in 2028, creating a near-term refinancing challenge for already-stressed borrowers. Banks hold an estimated $300 billion in exposure to private credit firms, raising concerns about potential contagion if distress spreads.
Moody's also flagged FS KKR's higher proportion of payment-in-kind income compared to peers, a metric the rating agency said signaled "weaker earnings quality." Payment-in-kind provisions allow borrowers to accumulate additional debt rather than make cash interest payments, potentially delaying the day of reckoning but increasing ultimate losses.
FS KKR pushed back against the downgrade, emphasizing its "strong, well‑laddered liability structure with no 2026 unsecured maturities" and approximately $2.5 billion in available liquidity after a $1 billion note repayment earlier this year. The company said it remains "well positioned" to support portfolio companies through the current market environment.
For the broader private credit industry, however, the combination of rising non-accruals, record redemption requests, and widening default forecasts suggests the easy-growth era may be drawing to a close. Investors who flooded into the asset class in search of yield are now confronting the reality that private credit, like traditional lending, is not immune to credit cycles.