Boston Fed researchers read 168 BDC filings and find borrowers deferring cash as lenders cut spreads

Three economists at the Federal Reserve Bank of Boston pulled the SEC filings of 168 business development companies, harmonized nearly 890,000 company-quarter loan records, and found the thing the private credit industry keeps saying is under control: borrowers are paying less in cash, and lenders are charging less to carry them. The paper, "Early Warning Signals in Private Credit?" by José Fillat, Leslie Sheng Shen, and Christina Wang, was published August 5. Its central number is the share of BDC loans using payment-in-kind interest, which rose from about 6% in early 2022 to roughly 10% by early 2026. Over the same stretch, median lending spreads narrowed by about a percentage point, to somewhere near 4 to 5 points over SOFR. Payment-in-kind means the borrower stops sending cash and instead rolls the quarter's interest onto the loan balance. It is the corporate-credit version of a merchant who used to remit daily and now asks to add this month's payment to the back of the deal. More borrowers doing that is a sign of cash-flow pressure. The Boston Fed calls the pairing a puzzle: if more borrowers cannot pay cash interest, lenders should be demanding more to hold that risk, not less. They are accepting less. That is what competition for deals does to underwriting discipline, and it is the same dynamic anyone funding small businesses has watched play out in their own channel when money gets cheap and everyone is chasing volume. The reason this matters for the funding world Plutus works in is the reason the authors wrote the paper at all. Private credit has grown past a trillion dollars, and almost none of it discloses what it holds. BDCs are the exception because they file quarterly 10-Qs and annual 10-Ks that list portfolio companies, loan terms, and fair-value marks. So the researchers used the one corner of the market that has to show its book to infer what the rest is doing. They also found that a BDC's own internal valuation carries information about its future stock return. A one-standard-deviation drop in the fair-value ratio lined up with about 50 basis points of weaker abnormal equity performance the next quarter, which is another way of saying the marks moved before the market did. The lenders knew first. The operator read Rising PIK next to falling spreads is the tell every funder should recognize: it means the book is getting weaker and the price is getting friendlier at the same time. When you see that in your own portfolio, more borrowers asking to defer while you cut factor rates to win the deal, the cash coverage on the tape is the number to trust, not the balance you carried forward. The paper also found concentration worth naming. Internet and software companies make up about 20% of the median BDC portfolio by loan count, and some BDCs run more than a third of their lending into technology. That is a very different risk shape than a diversified small-business book, and it means a downturn in one sector could hit several large lenders at once. On the systemic question the authors are calmer: bank credit commitments to BDCs grew from about $10 billion in 2013 to more than $50 billion by 2025, with roughly $35 billion actually drawn, but that still equals less than 2% of large banks' Tier 1 capital. The contagion path from private credit back into the banking system is real but, for now, small. What is not small is the diagnostic. As the authors put it, in a market that runs "behind a veil of privacy," BDCs "provide the only comprehensive, real-time insight into lending conditions." A federal reserve bank just told everyone that the way to read private credit stress is to stop listening to the marketing and start reading the loan schedules, because the schedules show deferrals before the press releases admit them. Opinion Cash paid is the only honest number on the tape Every funder eventually faces the choice the BDCs are making now: let a stressed borrower defer and keep the loan marked at par, or record the stress and eat the mark. Deferral is not fraud, and it is sometimes the right call. But a book that grows its balances while its cash collections shrink is telling you something the balance is hiding, and the lenders who survive the next cycle will be the ones who tracked cash paid, recorded modifications as modifications, and priced the risk they were actually carrying instead of the risk they wished they were. More on how funder behavior shows up in the numbers at plutusai.net .