## Introduction ## Source details **Canonical URL:** [Introduction](https://www.imf.org/-/media/files/publications/gfsr/2026/october/english/backgroundanalysis13.pdf) ## Other formats - [Markdown version](/-/media/files/publications/gfsr/2026/october/english/backgroundanalysis13.pdf.md) - [Structured JSON version](/-/media/files/publications/gfsr/2026/october/english/backgroundanalysis13.pdf.json) --- ### Scope and focus - The Global Financial Stability Report (Chapter 1) examines two key developments in the direct lending (DL) ecosystem: - the credit risk profile of DL borrowers, with emphasis on their ability to meet cash obligations from internally generated cash flows; and - liquidity risks in direct lending funds, particularly how potential disruptions in asset-based lending (ABL) facilities may create or amplify liquidity mismatches during stress. ### Context and systemic relevance - DL is defined as private leveraged finance for middle-market and smaller large-cap companies. - Outstanding DL loans globally reached nearly $2 trillion. - Most DL borrowers are private equity (PE) owned, with PE sponsors playing an important role in supporting portfolio companies during periods of stress. - DL connects cross-border to banks, life insurers, and other institutional investors, creating deep interconnectedness that raises policy challenges for the resilience of the broader financial system. ### Recent developments raising vulnerabilities - Leverage has increased across the private asset industry at both the fund level and among borrowers. - Prolonged uncertainty has sharply reduced sales of PE portfolio companies and capital distributions to investors, prompting greater use of NAV loans at the fund level and dividend recapitalizations at portfolio companies. - Semiliquid vehicles have become a major source of capital formation in the US DL ecosystem, increasing the role of investor inflows and outflows in DL credit availability. - These trends have increased contingent liquidity risks and the potential for procyclical behavior during stress, challenging the notion that private asset markets provide patient, countercyclical, or acyclical capital. *Global Financial Stability Report (Chapter 1), IMF | October 2026* ### Credit risk profile of direct lending borrowers - Aggregate metrics have improved owing to declining policy rates and nominal EBITDA growth over the past two years, which improved aggregate debt-service capacity and reduced the share of DL borrowers with interest coverage ratios lower than 1. - Despite aggregate improvement, a sizeable share of borrowers remains financially weak: - Approximately 20 percent have a fixed charge coverage ratio below 1. - An even higher percentage generate negative free operating cash flow. - These borrowers depend on previously accumulated liquidity reserves and on external support including sponsor equity, lender concessions, amendments and extensions, and payment in kind. - Increasing use of dividend recapitalizations has contributed to higher borrower leverage, with median debt-to-EBITDA ratios rising sequentially, notably in software and consumer service industries. - Vulnerable tail details: - Borrowers rated “ccc+” and below represent around 15 percent of all borrowers and carry median leverage of roughly 13 times debt to EBITDA. - The typical DL borrower—generally associated with a “b-” credit score—is leveraged at about 7 times debt to EBITDA. - Persistently negative free operating cash flow erodes liquidity buffers, reducing resilience to earnings shocks and funding disruptions and increasing the likelihood and severity of defaults. ### Software sector specifics - Software borrowers have been among stronger-performing DL segments by reported fundamentals and realized credit outcomes. - Market perceptions of AI-related disruption risk evolved considerably during 2026: - Public software equities declined broadly earlier in the year but recovered substantially since May, with many software segments posting gains and discounts remaining relatively moderate. - AI-related concerns contributed to uncertainty around private credit exposures to software and were among factors associated with elevated redemptions from semiliquid private credit vehicles during the first half of 2026. - Credit repricing: - Traded broadly syndicated loans (BSL) of software borrowers declined sharply in Q1 2026, while DL software loan valuations adjusted more moderately. - Within DL, valuation declines concentrated among higher-leverage borrowers. *Global Financial Stability Report (Chapter 1), IMF | October 2026* ### Liquidity risks in direct lending funds - Key liquidity risk drivers highlighted: - Investor redemptions from semiliquid funds since late 2025 created significant liquidity demands (April 2026 Global Financial Stability Report). - Borrowers’ contingent demand for liquidity via undrawn commitments (revolvers, delayed-draw term loans). - Contraction of DL funds’ borrowing capacity under ABL facilities as collateral quality deteriorates. - Borrowers’ contingent demand for liquidity: - Typical DL financing packages include a term loan (majority distributed at closing), a delayed draw term loan, and a corporate revolver that often remains mostly undrawn. - Such commitments are procyclical: borrowers are most likely to draw them during stress, either to meet genuine needs or as precautionary “dash for cash” behavior. - Some DL funds can rely on dry powder or subscription facilities; for many seasoned funds, primary liquidity is undrawn ABL facilities. - Unfunded commitments to borrowers may exceed currently available borrowing capacity from undrawn secured credit facilities or cash balances. For some vehicles, commitments exceed available capacity. - Available ABL capacity during a major shock: - ABL facilities use DL loans as collateral, marked to fair value and subject to valuation haircuts, eligibility, and concentration limits that determine the “borrowing base.” - An ABL that is comfortably overcollateralized in normal times may become undercollateralized (“borrowing base deficiency”) during a severe downturn due to loss of eligibility or declines in collateral valuations. - If uncured, a borrowing base deficiency typically constitutes an event of default under the facility documentation, suspending further borrowing and requiring immediate cash injection or additional eligible collateral. - In practice, the borrowing base may exceed the drawn amount by only a modest margin and can be well below the total committed amount, meaning much of nominal undrawn capacity can be unavailable. - Industrywide estimates often overstate available ABL capacity by approximating it as the difference between total commitments and drawn amounts and by combining ABL and subscription facilities in the same calculation. - During a severe downturn the ability to substitute unencumbered eligible collateral is likely to be limited. - Bank responses and coordination challenges: - Banks may in principle respond to a borrowing base deficiency with forbearance—amending facilities to broaden eligibility criteria—or by accelerating the facility. - Forbearance is often economically preferred because the collateral pool typically generates cash interest well in excess of the facility's funding cost; the underlying DL portfolio generally earns credit spreads of approximately 450 basis points or more, whereas ABL facilities are typically funded at spreads of 150–200 basis points or more. - Material amendments and forbearance generally require majority lender consent. Large ABL facilities are often syndicated across geographically diverse banks, and coordination challenges may impede amendments—particularly if some international lenders seek to reduce cross-border exposures—potentially forcing acceleration. - If accelerated, ABL lenders’ focus shifts from providing countercyclical support to maximizing immediate recoveries from collateral, disrupting the bilateral, patient-capital model of direct lending and curtailing support for stressed borrowers. *Global Financial Stability Report (Chapter 1), IMF | October 2026* ### 1. Liquidity Commitments Extended to Borrowers ### Overview - The chapter identifies a key vulnerability in the direct lending ecosystem arising from the interaction between credit risk and liquidity risk. - Highly leveraged borrowers are most likely to demand liquidity support during periods of stress, while contingent funding arrangements that direct lending (DL) funds rely upon may become less available as collateral quality deteriorates. - The rapid growth of fund finance, semiliquid vehicles, and cross-sector linkages has transformed private asset vehicles into more complex and interconnected intermediaries, increasing the potential for shocks to propagate across banks and nonbank financial institutions. ### Asset-Based Lending (ABL) Facilities: Definition and Function - An asset-based lending (ABL) facility is a secured credit facility, typically provided by banks as a revolving facility to a direct lending fund and collateralized by a defined pool of the fund’s loan assets. - The amount available to borrow is determined by a contractual borrowing base, which is calculated by applying eligibility criteria, concentration limits, valuation haircuts, and advance rates to the pledged collateral. - The borrowing base adjusts dynamically as the composition, performance, or valuation of the underlying loan portfolio changes, causing borrowing capacity to expand or contract over time. - Distinctions from subscription facilities: - ABL facilities are secured by the fund’s invested assets and are primarily used to provide portfolio-level leverage and liquidity, support new loan originations, and manage cash flows throughout the life of the fund. - Subscription facilities are secured primarily by investors’ uncalled capital commitments and are intended to bridge capital calls. - ABL facilities typically restrict eligible collateral to performing, mostly cash-paying, first-lien loans that satisfy leverage (generally below 6x debt/EBITDA), jurisdiction, currency, maturity, and concentration limits. - Loans with excessive payment-in-kind interest, or those that become nonaccrual, defaulted, distressed, or otherwise impaired, are generally excluded from the borrowing base. ### Borrowing Base: Formula and Mechanics - Borrowing Base = Σ (Fair Value × Advance Rate × Eligibility) − Concentration Deductions — Other Reserves - Eligible collateral is assigned advance rates that vary with the underlying credit quality and structural characteristics of the assets. - As collateral quality deteriorates, the borrowing base can contract, reducing available liquidity and potentially triggering drawdowns or margin pressures. ### Sample Advance Rates (by coupon PIK status) - Sample advance rates for the collateral in an ABL facility, by coupon payment-in-kind (PIK) status (No PIK / Moderate PIK): - First-lien loans: 75% / 55% - Second-lien loans: 65% / 55% - High-yield bonds: 60% / 50% - Mezzanine investments: 55% / 45% ### Sample Concentration Limits for Collateral in an ABL Facility - Single issuer concentration limit: - Exposure to a single issuer contributes to the borrowing base in full until it reaches 6 percent of the borrowing base. Any additional exposure between 6 percent and 12 percent contributes at only 50 percent, while exposure above 12 percent contributes nothing to the borrowing base. - Single industry concentration limit: - Exposure to any one industry can represent up to 25 percent of the borrowing base (30 percent for one designated industry). Any excess does not count toward the borrowing base. - Non-Core Investments limit: - Non-Core (i.e., riskier or lower quality) investments can represent up to 20 percent of the borrowing base. Any excess does not count toward the borrowing base. - Limit on combined exposure to Junior and Non-Core investments: - The combined exposure to Junior and Non-Core investments can represent up to 30 percent of the borrowing base. Any excess does not count toward the borrowing base. ### Conclusion and Policy Recommendations - Conclusion: - The interaction of credit risk and liquidity risk can amplify funding pressures across the financing chain, undermining the patient-capital model that has traditionally distinguished private credit from more procyclical forms of lending. - Recommendations for authorities: - Strengthen monitoring across the entire financing chain, from portfolio companies and special-purpose vehicles to funds, banks, and end investors. - Close data gaps on leverage, contingent liquidity commitments, and cross-sectoral and cross-border exposures. - Develop stress-testing and surveillance frameworks that capture how shocks may propagate through private asset markets and their links to the broader financial system. - Use existing supervisory and regulatory tools to address excessive exposures where private credit vulnerabilities pose material risks to banks, insurers, and other regulated institutions. - If private credit continues to expand and becomes systemically important, authorities may need to consider a more intrusive supervisory and regulatory framework (April 2024 Global Financial Stability Report). *Global Financial Stability Report Chapter 1, IMF | October 2026* ### Introduction ### Introduction ### Scope and focus - The Global Financial Stability Report (Chapter 1) examines two key developments in the direct lending (DL) ecosystem: - the credit risk profile of DL borrowers, with emphasis on their ability to meet cash obligations from internally generated cash flows; and - liquidity risks in direct lending funds, particularly how potential disruptions in asset-based lending (ABL) facilities may create or amplify liquidity mismatches during stress. ### Context and systemic relevance - DL is defined as private leveraged finance for middle-market and smaller large-cap companies. - Outstanding DL loans globally reached nearly $2 trillion. - Most DL borrowers are private equity (PE) owned, with PE sponsors playing an important role in supporting portfolio companies during periods of stress. - DL connects cross-border to banks, life insurers, and other institutional investors, creating deep interconnectedness that raises policy challenges for the resilience of the broader financial system. ### Recent developments raising vulnerabilities - Leverage has increased across the private asset industry at both the fund level and among borrowers. - Prolonged uncertainty has sharply reduced sales of PE portfolio companies and capital distributions to investors (see Figure 1.3.1, panel 1), prompting greater use of NAV loans at the fund level and dividend recapitalizations at portfolio companies. - Semiliquid vehicles have become a major source of capital formation in the US DL ecosystem, increasing the role of investor inflows and outflows in DL credit availability (see Figure 1.3.1, panel 2). - These trends have increased contingent liquidity risks and the potential for procyclical behavior during stress, challenging the notion that private asset markets provide patient, countercyclical, or acyclical capital. *Global Financial Stability Report (Chapter 1), IMF | October 2026* ### Credit risk profile of direct lending borrowers - Aggregate metrics have improved owing to declining policy rates and nominal EBITDA growth over the past two years, which improved aggregate debt-service capacity and reduced the share of DL borrowers with interest coverage ratios lower than 1 (see Figure 1.3.2, panel 1). - Despite aggregate improvement, a sizeable share of borrowers remains financially weak: - Approximately 20 percent have a fixed charge coverage ratio below 1. - An even higher percentage generate negative free operating cash flow. - These borrowers depend on previously accumulated liquidity reserves and on external support including sponsor equity, lender concessions, amendments and extensions, and payment in kind. - Increasing use of dividend recapitalizations has contributed to higher borrower leverage, with median debt-to-EBITDA ratios rising sequentially (see Figure 2, panel 2), notably in software and consumer service industries. - Vulnerable tail details: - Borrowers rated “ccc+” and below represent around 15 percent of all borrowers and carry median leverage of roughly 13 times debt to EBITDA. - The typical DL borrower—generally associated with a “b-” credit score—is leveraged at about 7 times debt to EBITDA. - Persistently negative free operating cash flow erodes liquidity buffers, reducing resilience to earnings shocks and funding disruptions and increasing the likelihood and severity of defaults (see Ferreira, Martell, and Yakovlev 2026). ### Software sector specifics - Software borrowers have been among stronger-performing DL segments by reported fundamentals and realized credit outcomes. - Market perceptions of AI-related disruption risk evolved considerably during 2026: - Public software equities declined broadly earlier in the year but recovered substantially since May, with many software segments posting gains and discounts remaining relatively moderate (see Figure 1.3.3, panel 1). - AI-related concerns contributed to uncertainty around private credit exposures to software and were among factors associated with elevated redemptions from semiliquid private credit vehicles during the first half of 2026. - Credit repricing: - Traded broadly syndicated loans (BSL) of software borrowers declined sharply in Q1 2026, while DL software loan valuations adjusted more moderately (see Figure 1.3.3, panel 2). - Within DL, valuation declines concentrated among higher-leverage borrowers. *Global Financial Stability Report (Chapter 1), IMF | October 2026* ### Liquidity risks in direct lending funds - Key liquidity risk drivers highlighted: - Investor redemptions from semiliquid funds since late 2025 created significant liquidity demands (April 2026 Global Financial Stability Report). - Borrowers’ contingent demand for liquidity via undrawn commitments (revolvers, delayed-draw term loans). - Contraction of DL funds’ borrowing capacity under ABL facilities as collateral quality deteriorates. - Borrowers’ contingent demand for liquidity: - Typical DL financing packages include a term loan (majority distributed at closing), a delayed draw term loan, and a corporate revolver that often remains mostly undrawn. - Such commitments are procyclical: borrowers are most likely to draw them during stress, either to meet genuine needs or as precautionary “dash for cash” behavior. - Some DL funds can rely on dry powder or subscription facilities; for many seasoned funds, primary liquidity is undrawn ABL facilities. - Unfunded commitments to borrowers may exceed currently available borrowing capacity from undrawn secured credit facilities or cash balances. For some vehicles, commitments exceed available capacity (illustrated using BDC balance sheets in Figure 1.3.4, panel 1). - Available ABL capacity during a major shock: - ABL facilities use DL loans as collateral, marked to fair value and subject to valuation haircuts, eligibility, and concentration limits that determine the “borrowing base.” - An ABL that is comfortably overcollateralized in normal times may become undercollateralized (“borrowing base deficiency”) during a severe downturn due to loss of eligibility or declines in collateral valuations. - If uncured, a borrowing base deficiency typically constitutes an event of default under the facility documentation, suspending further borrowing and requiring immediate cash injection or additional eligible collateral. - In practice, the borrowing base may exceed the drawn amount by only a modest margin and can be well below the total committed amount, meaning much of nominal undrawn capacity can be unavailable (see Figure 1.3.4, panel 2). Industrywide estimates often overstate available ABL capacity by approximating it as the difference between total commitments and drawn amounts and by combining ABL and subscription facilities in the same calculation. - During a severe downturn the ability to substitute unencumbered eligible collateral is likely to be limited. - Bank responses and coordination challenges: - Banks may in principle respond to a borrowing base deficiency with forbearance—amending facilities to broaden eligibility criteria—or by accelerating the facility. - Forbearance is often economically preferred because the collateral pool typically generates cash interest well in excess of the facility's funding cost; the underlying DL portfolio generally earns credit spreads of approximately 450 basis points or more, whereas ABL facilities are typically funded at spreads of 150–200 basis points or more. - Material amendments and forbearance generally require majority lender consent. Large ABL facilities are often syndicated across geographically diverse banks, and coordination challenges may impede amendments—particularly if some international lenders seek to reduce cross-border exposures—potentially forcing acceleration. - If accelerated, ABL lenders’ focus shifts from providing countercyclical support to maximizing immediate recoveries from collateral, disrupting the bilateral, patient-capital model of direct lending and curtailing support for stressed borrowers. *Global Financial Stability Report (Chapter 1), IMF | October 2026* ### 1. Liquidity Commitments Extended to Borrowers ### 1. Liquidity Commitments Extended to Borrowers ### Overview - The chapter identifies a key vulnerability in the direct lending ecosystem arising from the interaction between credit risk and liquidity risk. - Highly leveraged borrowers are most likely to demand liquidity support during periods of stress, while contingent funding arrangements that direct lending (DL) funds rely upon may become less available as collateral quality deteriorates. - The rapid growth of fund finance, semiliquid vehicles, and cross-sector linkages has transformed private asset vehicles into more complex and interconnected intermediaries, increasing the potential for shocks to propagate across banks and nonbank financial institutions. ### Asset-Based Lending (ABL) Facilities: Definition and Function - An asset-based lending (ABL) facility is a secured credit facility, typically provided by banks as a revolving facility to a direct lending fund and collateralized by a defined pool of the fund’s loan assets. - The amount available to borrow is determined by a contractual borrowing base, which is calculated by applying eligibility criteria, concentration limits, valuation haircuts, and advance rates to the pledged collateral. - The borrowing base adjusts dynamically as the composition, performance, or valuation of the underlying loan portfolio changes, causing borrowing capacity to expand or contract over time. - Distinctions from subscription facilities: - ABL facilities are secured by the fund’s invested assets and are primarily used to provide portfolio-level leverage and liquidity, support new loan originations, and manage cash flows throughout the life of the fund. - Subscription facilities are secured primarily by investors’ uncalled capital commitments and are intended to bridge capital calls. - ABL facilities typically restrict eligible collateral to performing, mostly cash-paying, first-lien loans that satisfy leverage (generally below 6x debt/EBITDA), jurisdiction, currency, maturity, and concentration limits. - Loans with excessive payment-in-kind interest, or those that become nonaccrual, defaulted, distressed, or otherwise impaired, are generally excluded from the borrowing base. ### Borrowing Base: Formula and Mechanics - Borrowing Base = Σ (Fair Value × Advance Rate × Eligibility) − Concentration Deductions — Other Reserves - Eligible collateral is assigned advance rates that vary with the underlying credit quality and structural characteristics of the assets. - As collateral quality deteriorates, the borrowing base can contract, reducing available liquidity and potentially triggering drawdowns or margin pressures. ### Sample Advance Rates (by coupon PIK status) - Sample advance rates for the collateral in an ABL facility, by coupon payment-in-kind (PIK) status (No PIK / Moderate PIK): - First-lien loans: 75% / 55% - Second-lien loans: 65% / 55% - High-yield bonds: 60% / 50% - Mezzanine investments: 55% / 45% ### Sample Concentration Limits for Collateral in an ABL Facility - Single issuer concentration limit: - Exposure to a single issuer contributes to the borrowing base in full until it reaches 6 percent of the borrowing base. Any additional exposure between 6 percent and 12 percent contributes at only 50 percent, while exposure above 12 percent contributes nothing to the borrowing base. - Single industry concentration limit: - Exposure to any one industry can represent up to 25 percent of the borrowing base (30 percent for one designated industry). Any excess does not count toward the borrowing base. - Non-Core Investments limit: - Non-Core (i.e., riskier or lower quality) investments can represent up to 20 percent of the borrowing base. Any excess does not count toward the borrowing base. - Limit on combined exposure to Junior and Non-Core investments: - The combined exposure to Junior and Non-Core investments can represent up to 30 percent of the borrowing base. Any excess does not count toward the borrowing base. ### Conclusion and Policy Recommendations - Conclusion: - The interaction of credit risk and liquidity risk can amplify funding pressures across the financing chain, undermining the patient-capital model that has traditionally distinguished private credit from more procyclical forms of lending. - Recommendations for authorities: - Strengthen monitoring across the entire financing chain, from portfolio companies and special-purpose vehicles to funds, banks, and end investors. - Close data gaps on leverage, contingent liquidity commitments, and cross-sectoral and cross-border exposures. - Develop stress-testing and surveillance frameworks that capture how shocks may propagate through private asset markets and their links to the broader financial system. - Use existing supervisory and regulatory tools to address excessive exposures where private credit vulnerabilities pose material risks to banks, insurers, and other regulated institutions. - If private credit continues to expand and becomes systemically important, authorities may need to consider a more intrusive supervisory and regulatory framework (April 2024 Global Financial Stability Report). --- _Source: https://www.imf.org/-/media/files/publications/gfsr/2026/october/english/backgroundanalysis13.pdf_