Where non-accrual loans hide in a private credit fund's statements, and why the rate at fair value flatters the funds that mark hardest.
Add up the cost and the fair value of every loan flagged as on non-accrual in the schedule of investments, then divide each by the cost and the fair value of the whole debt portfolio. In an illustrative private credit fund, four loans with a cost of 52,000 and a fair value of 21,500 give a non-accrual rate of 5.20 per cent at cost but only 2.23 per cent at fair value. Funds often quote the fair value figure, and it is lower precisely because the loans have been marked down.
Worked in full in How to Read a Private Fund's Financial Statements by Julian R. Sterling, with every figure reproduced in a free workbook.See the book on Amazon →
A loan goes on non-accrual when the fund stops recognising interest income on it, usually because payments are 90 days or more overdue or because the manager no longer expects to collect in full. It is the earliest hard signal of credit trouble a private credit fund's statements give, earlier than a realised loss. The statements rarely print the ratio itself; they flag the loans with a footnote marker in the schedule of investments and describe the policy in the notes. The calculation is yours to make.
| Loan on non-accrual | Cost | Fair value | FV / cost | Contractual rate |
|---|---|---|---|---|
| Loan A | 18,000 | 9,900 | 55.0% | 11.50% |
| Loan B | 14,000 | 5,600 | 40.0% | 10.75% |
| Loan C | 12,500 | 4,400 | 35.2% | 12.00% |
| Loan D | 7,500 | 1,600 | 21.3% | 13.00% |
| Total | 52,000 | 21,500 | 41.3% |
The whole debt portfolio, 110 loans, has a cost of 1,000,000 and a fair value of 962,000. Net assets are 560,000, the difference being the fund's borrowing. Performing loans yield 10.90 per cent on cost.
Non-accrual rate at cost = 52,000 ÷ 1,000,000 = 5.20%
Non-accrual rate at fair value = 21,500 ÷ 962,000 = 2.23%
By number of loans = 4 ÷ 110 = 3.6%
Excel, with a non-accrual flag in column F: =SUMIFS(Cost,F:F,"NA")/SUM(Cost) and the same on the fair value column
The two rates measure different things. At cost, the ratio says how much of the capital the manager lent has stopped paying. At fair value, it says how much of today's portfolio value sits in loans that pay nothing, after the manager's own estimate of the loss. Because the marks average 41.3 per cent of cost, the second number is less than half the first.
Contractual interest no longer accrued = Σ cost × rate = 2,070 + 1,505 + 1,500 + 975 = 6,050 a year, 1.08% of NAV
Weighted average yield at cost including non-accruals at zero = 948,000 × 10.90% ÷ 1,000,000 = 10.33%, against 10.90% on performing loans
Unrealised loss on the four loans = 52,000 − 21,500 = 30,500, 5.45% of NAV
The income line is where the problem shows first: 6,050 of interest that the fund would otherwise have reported as investment income, and the weighted average yield falls by 0.57 of a point. If any of these loans paid interest in kind before going on non-accrual, the PIK it accrued may be reversed too; see how much of a private credit fund's income is PIK for where that sits in the statements. The NAV has already absorbed the 30,500 loss through unrealised depreciation, so a later sale or restructuring at the marked value changes the realised and unrealised lines but not NAV.
| Marks, FV / cost | FV of non-accruals | Rate at fair value | Rate at cost |
|---|---|---|---|
| 20.0% | 10,400 | 1.09% | 5.20% |
| 41.3% | 21,500 | 2.23% | 5.20% |
| 60.0% | 31,200 | 3.21% | 5.20% |
| 80.0% | 41,600 | 4.24% | 5.20% |
The fair value rate moves with the marks, not with credit quality. The harsher the write-down, the better the headline ratio looks. The rate at cost does not move at all, which is why it is the one to track over time and across managers.
Comparing two funds on their fair value non-accrual rates. Take a second fund, also 1,000,000 at cost, with 40,000 of non-accruals at cost, marked at 80 per cent to 32,000, in a portfolio worth 990,000. Its rate at fair value is 3.23 per cent, a full point worse than this fund's 2.23 per cent, so it looks like the weaker book. At cost it is 4.00 per cent against 5.20 per cent: it has less capital in trouble and simply marks it more optimistically. Whether those marks are right is a separate question, answered by the Level 3 roll-forward and by what the loans eventually realise.
Watch the exits too. A loan leaves the non-accrual list when it is restructured, sold or written off, and a falling ratio can mean any of the three. Check the realised losses for the year and any new loans to the same borrower in the schedule before reading a lower rate as an improvement.
Compute the non-accrual rate both ways: here 5.20 per cent of cost and 2.23 per cent of fair value, with 6,050 of interest a year no longer accruing and 30,500 of loss already in NAV. Compare managers at cost, and use fair value only to see how much of NAV is at risk. The full schedule-to-statements reconciliation is worked in the free workbooks for the book.
Track it at cost and compare managers at cost. The fair value rate falls when loans are written down: the illustrative fund's four non-accrual loans are 5.20% of cost but 2.23% of fair value, because they are marked at 41.3% of cost. Marked at 20.0% the fair value rate would be 1.09%.
Typically when principal or interest is 90 days or more past due, or when the manager doubts full collection, as set out in the fund's accounting policy note. From then on interest is not recognised as income. In the illustrative fund that removes 6,050 a year of contractual interest, 1.08% of NAV.
They earn nothing, so they dilute the yield at cost. Performing loans yielding 10.90% on 948,000 of cost give a portfolio yield of 10.33% on the full 1,000,000 once the 52,000 of non-accrual loans are included at zero, a drop of 0.57 of a point.
This article is one calculation from How to Read a Private Fund's Financial Statements. The book takes the same case from first principles to the decision, chapter by chapter, and every figure it prints is a live formula in the free companion workbooks.
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