HLI Flags Rising Stress Among Smaller Private-Credit Borrowers

Private-credit defaults among borrowers with under $100 million of EBITDA reached 3.0% by loan value and 3.6% by borrower count in Q2 2026, with 12% of $10 million-$20 million EBITDA loans trading below 90% of par versus about 1% in 2023. Aggregate defaults remain contained at 0.8% of principal despite 2.5% of borrowers being in default, while healthcare showed the highest stress at 4.2% of borrowers. Median revenue and EBITDA still grew 6.5% and 7.4% year over year, but worsening marks in smaller credits could tighten underwriting and lift restructuring, valuation and capital-solutions demand for Houlihan Lokey.

Analysis

The important transmission channel is not broad private-credit losses but NAV credibility at BDCs and alternative asset managers with meaningful lower-middle-market exposure. If secondary marks remain weak, managers face a lagged sequence of higher non-accruals, tighter originations, lower fee-earning AUM growth, and potentially dividend-coverage pressure. Public proxies with more middle-market concentration—ARCC, OBDC, FSK, BXSL and ARES—should be differentiated by sub-$100m EBITDA exposure, healthcare-services concentration, covenant protection and the share of portfolio already on non-accrual; headline sector default rates will understate this risk.

HLI and PJT have positive operating leverage to a rise in amendments, liability management and formal restructurings, but the equity implication is asymmetric. HLI’s broad capital-markets and M&A exposure means a modest rise in small-company workouts may not offset a weak transaction environment; PJT has cleaner restructuring beta and could see estimate upgrades if mandates migrate from consensual amendments to chapter 11 or distressed exchanges over the next 1-3 quarters. The contrarian point is that contained PIK usage and continued borrower growth imply a workout cycle, not yet a systemic credit event—shorting diversified alternatives now is premature absent a meaningful acceleration in non-accruals or forced NAV marks.

Healthcare is the clearest second-order watchpoint: reimbursement pressure, labor costs and sponsor leverage can turn modest EBITDA misses into liquidity events because smaller issuers have limited refinancing alternatives. Over 6-18 months, reduced lender appetite for small-unitranche loans should widen spreads and favor scaled direct lenders with permanent capital and strong deal sourcing, while reducing exit multiples for highly levered small-cap sponsor-backed assets.

Key Decisions for Investors

• Initiate a 3-6 month relative-value position: long PJT / short HLI, sized beta-neutral. PJT offers more direct restructuring sensitivity; reassess if restructuring revenue/backlog fails to improve at the next earnings update or broad M&A recovery accelerates.
• Do not add directional shorts in ARCC, OBDC, FSK, BXSL or ARES solely on this signal. Build a portfolio-exposure dashboard before action: sub-$100m EBITDA loans, healthcare exposure, non-accrual migration, realized versus unrealized losses, and NAV marks are the required triggers.
• Use any broad BDC selloff to selectively accumulate ARCC or BXSL only after verifying limited lower-middle-market and healthcare concentration; target a 6-12 month hold. Thesis is falsified by two consecutive quarters of rising non-accruals, NAV decline exceeding dividend coverage, or a material cut to distribution guidance.
• Watch healthcare-services credit spreads and BDC quarterly marks over the next 60-90 days. A second consecutive increase in below-par loans or amended/PIK interest above current low levels would justify buying PJT calls or reducing BDC exposure; without that confirmation, treat this as a dispersion trade rather than a macro-credit short.