What is behind the elevated "defaults" in private credit?

Rising financing costs are fueling investor concerns about private credit. Once favored for its income-generating potential when rates were low, this asset class is now under intense scrutiny as rates climb. Rising rates can have a more pronounced effect on private credit because many loans in this sector are structured with floating rates. As benchmark rates increase, borrowers face higher interest expenses, which may strain their cash flows and add to the risk of default. This means that both lenders and borrowers must continually adjust to changing market conditions.

Stress within private credit has mostly been idiosyncratic, concentrated in specific sectors. Even today, it is the direct lending segment of the private credit market that is attracting the most attention, but this is still less than half of the overall private credit market.

Performance remains robust with strong returns in recent periods. However, headlines about elevated default rates challenge this narrative, raising questions about whether private credit is now facing its first genuine credit cycle.

Understanding the nuances of defaults and the unique nature of private credit markets is essential for investors navigating this space.

The multiverse of “default” rates

Private credit markets feature a range of definitions for "default", which vary among index providers and lead to dispersion in reported figures. Traditionally, a loan default means failing to meet repayment obligations and is a hard rule in public bond markets. Private lending, by contrast, offers more flexibility for both borrowers and lenders.

Private credit’s broader definition of default often captures market distress rather than just missed payments. These measures include lender-agreed changes to loan terms and liability management exercises designed to create flexibility, which can help avoid outright default. Distressed exchanges, non-accruals, payment-in-kind (PIK), maturity extensions, covenant breaches or amendments are all commonly captured in default rates while not being actual defaults.¹

Index providers adopt different combinations of distress signals in their definition of “default”. So, while certain indices may show elevated levels of ‘default’, more narrowly defined conventional default rates may be more comparable and have remained well below 2% in recent months (Exhibit 1).

PIKing through the details

PIK is a common metric used to capture market stress and is often captured within default rates. However, even here, the treatment of PIK can vary widely. PIK amendments occur when lenders agree to capitalize periodic cash payments into the loan’s end value. The use of PIK has increased in recent years (click to GTA P69), with implied default being used as an indicator of market stress. However, there’s a distinction between loans with PIK options embedded from the outset and those where it was added later.

"Amended PIK" refers to PIK features that were added to a loan after origination, often as a response to financial distress. When a borrower negotiates to switch from cash interest payments to PIK, it typically signals that they are struggling to meet their obligations. In contrast, loans with PIK options embedded from the outset are usually structured that way for flexibility, not because the borrower is in financial strife.

Most of the rise in PIK comes from loans originated with this feature (or toggle in private credit jargon), reflecting a financing choice rather than distress. Conversely, the current share of "amended PIK" remains marginally less than a third of all PIK loans, suggesting more limited deterioration in loans.

The recovery edge

A default in private credit is often the start of a negotiation, not the end of a loan. Realized losses are crucial for investment portfolios, with recovery rates determining how much debt defaulted versus the losses ultimately borne by investors.

Default rates for private credit, high yield and leveraged loans are similar, at 2.0%, 1.9% and 1.2%, respectively. Despite slightly higher default rates, private credit has a higher recovery rate (41.7% versus 37.9% and 39.0% for high yield and leveraged loans respectively).²  Recovery rates are often higher than in public markets because borrowers can negotiate directly with lenders.

Similarly, although unrealized losses on private credit may appear worrying at first glance, tracking at 1.6% on a trailing four-quarter basis by 2Q26 relative to 2025’s 0.4%³, aggregate fundamentals remain supportive. For example, leverage ratios among private borrowers have fallen below pre-pandemic levels in recent years (4Q19: 6.2x, 2Q26: 5.6x), while interest coverage has strengthened (Exhibit 2). This may help cushion borrowers against rising financing costs.

The maturity wall is a ramp, not a cliff

The private credit maturity wall has become a focal point for the market. The concern is that heavy refinancing will be needed, potentially at much higher rates than when the loans were originated. Borrowers typically begin refinancing well before maturity, leading to a ramp-up rather than a sudden cliff.

The main risk is refinancing, not defaults, given higher rates and pockets of stress. ‘SaaSocalypse’ fears have fueled markdowns in software-related loans and at USD 202billion, software accounts for approximately a fifth of business development company lending. USD 50billion of this matures in 2028 or earlier, with 30% rated at CCC+ or below⁴, which could amplify refinancing risks for this segment.

However, the software sector has staged a remarkable recovery across both public and private markets since the SaaSocalypse fears emerged earlier this year. Software continued to have the lowest default rate among other sectors⁵, with 74% and 68% of software companies still expanding revenue and earnings on a year-over-year basis⁶. This suggests that the ultimate impact could remain manageable

Investment implications

Elevated “default” rates on broad measures may weigh on perceptions of private credit health, but conventional default rates suggest a more constructive outlook. Higher benchmark rates support income on floating-rate loans, while simultaneously increasing debt-service burdens for borrowers. The longer rates remain elevated, the more important underlying credit quality becomes.

Risks are becoming more differentiated as private credit may be facing its first real credit cycle. However, as with investing in many asset classes, discipline can bring opportunity. A disciplined approach to direct lending, asset-based finance and more complex financing solutions is a way to generate portfolio income. Senior secured exposure to larger borrowers offers better protection than junior debt, while asset-based finance adds return drivers less tied to corporate leverage and software.

This is a market for active, selective allocation, with wider spreads improving the entry point for new capital.

¹ Payment default refers to a failure to make scheduled principal or interest payments when due; distressed exchange refers to a creditor accepting revised securities or terms that reduce the economic value of the original obligation to avoid a conventional default; non-accrual refers to a loan for which the lender has stopped recognising interest income due to uncertainty over collection; payment-in-kind (PIK) refers to interest that is capitalized into the loan balance rather than paid in cash; maturity extension refers to an agreement to postpone the contractual repayment date; covenant breach refers to a borrower’s failure to comply with contractual financial or non-financial requirements, while a covenant amendment refers to a negotiated change or waiver of those requirements, often to provide additional flexibility and avoid a breach.

² Source: J.P. Morgan Global Research, KBRA DLD, Solve.

³ Source: Cliffwater Direct Lending Index. Realized losses refer to the component of loan valuation change for completed transactions, such as write-downs of loan principal that result from borrower default. Unrealized losses refer to the component of loan valuation change that is sourced by a change in market price or a change in “fair value” not attributable to a transaction.

⁴ Source: S&P Global.

⁵ Source: Fitch.

⁶ Source: Lincoln International. Revenue refers to trailing 12-month revenue. Earnings refer to trailing 12-month adjusted EBITDA.

5e90e373-d7a7-11f1-90ec-310bb13add90

IMPORTANT DISCLAIMER on Artificial Intelligence (AI): This media contains AI generated or enhanced contents, including but not limited to the image, voice, and spoken contents of JPMorgan Asset Management representatives. These elements have been created or modified using AI technology and do not represent an actual recorded appearance/presence or live presentation by the individual. The representations, translations, and avatars in this media may not accurately reflect real individuals, events, or languages. This media is intended for informational purposes only and should not be relied upon as a sole source for decision-making.