Private credit stress: financial reporting risks

Potential macroeconomic implications

The current stress in the private credit market has raised concerns about the valuation of private credit assets and the future availability and pricing of private credit to borrowers. What’s more, a weakening in the private credit market could introduce volatility and stress across the broader economy, particularly exposing highly leveraged companies to these developments.

The impact could be amplified given expectations that a significant number of private credit loans will be entering a refinancing window in the near term. Even so, the rising cost of capital could also be generally felt across the broader economy, including entities without direct exposure to the private credit market. 

Accounting considerations

This weakening of the private credit market could require many entities to reassess a wide range of accounting estimates, judgments, and disclosures under U.S. GAAP and to modify existing contracts, even in the absence of direct exposure to the private credit market. Below are some of the financial reporting issues that may be most salient for those entities with direct exposure to the private credit market, including lenders, investors, and borrowers, as well as other entities.

Lender and investor considerations

Investors in private credit funds as well as the funds themselves will need to consider the accounting implications of stress in the private credit market on loan valuations and on modifications to loans in response to borrower distress.

Fair value measurement and credit losses

Many private credit funds (and, therefore, their investors) currently account for private credit loans at fair value. Private credit loans are inherently illiquid and lack active secondary markets, resulting in a greater reliance on valuation judgment due to the limited number of comparable transactions. In addition, during times of rapidly changing economic or borrower-specific conditions, informational lags could inappropriately delay loss recognition, so that entities will need to ensure they have adjusted fair value estimates to account for any out-of-date economic or borrower information.

In stressed credit conditions, entities measuring assets or liabilities at fair value also need to assess the following:

• Whether observable transactions remain orderly under ASC 820
• The impact of widening credit spreads, decreased liquidity, and elevated volatility on valuation inputs
• Appropriate weighting of observable versus unobservable inputs when market data becomes less reliable

Importantly, fair value remains a market‑based measurement, even in distressed conditions. Investors and lenders in private credit vehicles need to carefully assess the valuation model inputs they are using for appropriateness while also considering the value of the collateral underlying the private credit loans. Complex structures, combined with complicated debt investments and leverage used by private credit vehicles, can make valuation even more challenging.

Similarly, private credit funds that do not account for their loans at fair value will need to evaluate whether their estimates of expected credit losses under ASC 326 have appropriately accounted for all relevant macroeconomic and borrower-specific factors.

Loan modifications

Private credit funds that do not measure their loans at fair value will need to restructure their financing receivables under ASC 310 to determine whether a restructuring is accounted for as a new financing receivable or as a modification of an existing financing receivable. 

Borrower considerations

Borrowers under private credit debt agreements may see increases in the cost of debt or may need to find alternative sources of financing altogether in response to stress in the private credit market.

This could have implications for a borrower’s financial reporting, including its going concern assessments, impairment evaluations, and accounting for debt modifications.

Going concern and disclosures

Entities must reassess going concern under ASC 205‑40, particularly those with near‑term debt maturities, a reliance on private credit refinancing, or covenant pressure. Incremental disclosures may be required for risks, uncertainties, concentrations, and significant estimates under ASC 275.

Debt modifications

Economic stress may cause borrowers to pursue renegotiations of debt terms. Borrowers must assess under ASC 470 whether these modifications result in debt extinguishments, triggering gains or losses, or in debt modifications, resulting in changes in effective interest rates. The prevalence of payment deferrals, covenant waivers, and maturity extensions would increase the complexity and judgment involved in applying ASC 470 and related guidance.

Impairment

A weakening of the private credit market could trigger impairment indicators, including declining cash flows, tightening liquidity, reduced access to capital, and declining valuation multiples, for many borrowers with long-lived assets and indefinite-lived intangible assets (including goodwill).

Macroeconomic deterioration, increased credit spreads, and declining market capitalization could constitute a “triggering event” under ASC 350, requiring interim impairment testing of goodwill and indefinite-lived intangibles (see Grant Thornton’s Impairment: Indefinite-lived intangibles and goodwill) (PDF - 1.20MB).

Reduced utilization, facility closures, liquidation of collateral depressing asset prices, or adverse changes in business climate could trigger recoverability testing under ASC 360 for long-lived assets and right-of-use assets (see Grant Thornton’s Applying ASC 360 to right-of-use assets).

General considerations

In addition, entities without direct exposure to the private credit market may also identify similar financial reporting implications of stress in the private credit market. Of particular concern are considerations related to asset impairment, including credit losses, and the impact of contract modifications (see Grant Thornton’s Implications of economic and fiscal uncertainty).

Impairment

The same impairment considerations for goodwill, indefinite‑lived intangibles, long‑lived assets, and right‑of‑use assets would apply for entities not directly involved in the private credit market. However, in a deteriorating economic environment, the reduced demand for an entity’s goods and services could further pressure operating performance. As a result, entities should also reassess inventory measurement, as contracted demand and increased pricing pressure may require them to remeasure inventory to the lower of cost or net realizable value.

Credit losses and financial instruments

Stress in the private credit market could heighten credit risk across loans, receivables, debt securities, and contract assets. Entities with financial instruments in the scope of the credit loss model in ASC 326 will need to incorporate deteriorating economic conditions, borrower stress, and reduced refinancing capacity into their estimates of expected credit losses. Equity investments in unconsolidated investees not carried at fair value could exhibit qualitative impairment indicators, requiring fair value write‑downs.

Contract modifications

Entities whose customers or borrowers experience negative impacts from a depressed private credit market may need to modify their existing contracts. Those modifications may have accounting and financial reporting implications, including

• Price concessions or other modifications to revenue contracts under ASC 606 (see Grant Thornton’s Revenue from Contracts with Customers: Navigating the guidance in ASC 606 and ASC 340-40)
• Rent concessions or other modifications to leases under ASC 842 (see Grant Thornton’s Leases: Navigating the guidance in ASC 842)