Why US private credit default rates range from Fitch’s 6.3% to PIMCO’s 19% and Houlihan Lokey’s sub-1%

Fitch Ratings said on Monday (September 14) that the US private credit default rate, based on a group of about 1,300 borrowers, rose to 6.3% in the 12 months to the end of August. That exceeded the previous record of 6.1% set in July. There were 14 defaults in August, the highest monthly total in the past year, compared with just three in July.

But two other figures for the same market — estimated at about US$1.8 trillion, although estimates vary by methodology, with Moody’s forecasting corporate lending to exceed US$2 trillion in 2026 — are far removed from Fitch’s number. Pacific Investment Management Company (PIMCO) calculated a “shadow default rate” of 19% for business development companies (BDCs), while investment bank Houlihan Lokey put the rate below 1% when weighted by loan size. The figures appear contradictory, but they cover different parts of the lending market and use different definitions of default.

Fitch counts extensions and delayed interest payments as defaults

Fitch’s 6.3% is a rolling 12-month figure. In addition to payment defaults, it includes debt extension transactions classified as defaults. Over the past 12 months, delayed interest payments and arrangements replacing cash interest with payment-in-kind interest (PIK, where additional debt is issued instead of cash interest) accounted for 47% of default events. Maturity extensions under stress accounted for 41%, while payment defaults made up about 8%. Maturity extensions have been the largest category of default for three consecutive months. Lyle Margolis, Fitch’s head of North American private credit, said uncertainty over interest rates and the inflation outlook had slowed transaction activity, making it difficult for distressed portfolio companies to be sold before their loans matured and pushing up default rates.

PIMCO covers only BDCs and measures the “stock” of troubled loans

PIMCO’s 19% is not a figure for the entire private credit market. It covers about US$500 billion in assets held by US BDCs, funds that invest in small and medium-sized private companies. PIMCO groups together five types of events: missed payments, non-accrual status — where the likelihood of receiving contractual payments is in doubt — a switch from cash interest to PIK after a loan was originated, material extensions, and debt-for-equity conversions. Loans that had a PIK option from the outset are excluded.

This is a “stock” measure: once a borrower is flagged, it remains included for as long as the situation persists. Based on PIMCO’s data to the end of March, the rate rose from about 14% in 2022 to 19%. PIMCO said, however, that the recent increase had begun to level off, and that most of the cases involved “soft” events such as debt-for-equity conversions, extensions and switches from cash interest to PIK.

Houlihan Lokey: larger borrowers pull down the overall rate

Houlihan Lokey, in data released on September 10 covering the second quarter, put the default rate at 0.8% when weighted by loan principal and 2.5% when measured by the number of borrowers, using a basic definition that includes technical and payment defaults. The gap reflects borrower size: the largest borrowers are generally still making payments on time. Among borrowers with EBITDA below US$100 million — the core of the direct lending market — the default rate was 3.0% when weighted by principal and 3.6% by borrower count. For borrowers with EBITDA of about US$10 million to US$20 million, around 12% of loans were valued at less than 90% of face value, compared with about 1% in 2023.

As for PIK, 11.8% of loans by value elected to pay part of their interest in PIK during the second quarter, but they accounted for only 6.3% when measured by the amount of interest. Houlihan Lokey regards “PIK terms added after origination” as the indicator most closely associated with borrower stress. Such loans accounted for only 1.6% when measured by interest. Another reference, Proskauer’s private credit default index — covering 716 senior secured and unitranche loans with a combined value of about US$195.6 billion — stood at 2.51% in the second quarter.

Fitch’s data also shows that stress is unevenly distributed. Defaults in healthcare, industrials and manufacturing rose from 9.5% to 9.9% in August, the highest among sectors. Technology and software recorded the lowest rate, falling from 1.2% to 0.6%.

Valuations: how are private assets priced?

Most companies borrowing through private credit are unlisted and are not required to disclose quarterly results publicly. Their assets are mainly valued by fund managers using models, without market transaction prices as a reference. Research by Credit Benchmark showed that the average risk assessment of BDCs fell 5% over the past two years, while the default risk of their related holdings rose 12%, according to Bloomberg.

Share prices of listed BDCs have diverged from their net asset values. A recent PIMCO report said BDC shares overall remained below NAV. According to a report on September 17, Ares Capital (Nasdaq: ARCC) had a price-to-book ratio of about 1.0 times and a dividend yield of about 9.8%, while Main Street Capital (New York Stock Exchange: MAIN) had a price-to-book ratio of about 1.6 times and a dividend yield of about 5.6%. BDCs are required to distribute at least 90% of their taxable income to shareholders. Common indicators include the ratio of non-accrual loans and the discount or premium of share prices to NAV.

Unlisted BDCs: redemption pressure has emerged

Unlisted BDCs offer quarterly repurchases at NAV, with most imposing a quarterly repurchase limit of about 5%. Data from Robert A. Stanger & Co. showed that repurchase requests in the second quarter amounted to 12.4% of NAV, the highest since the firm began keeping records, compared with 10.4% in the first quarter. Fund managers fulfilled 38% of requests, returning about US$5.9 billion to investors. Net outflows during the period were about US$3.8 billion, marking a second consecutive quarter of net outflows.

Fed rate hike raises costs for floating-rate borrowers

The Federal Reserve voted unanimously on Wednesday (September 16) to raise interest rates by 25 basis points, lifting the federal funds target range to 3.75% to 4%. It was the first rate increase in more than three years, and the Fed signalled that it would raise rates once more this year. Private credit loans are mostly floating-rate, so higher benchmark rates increase borrowers’ interest burdens.

What to watch next

First, whether the gap between the three sets of figures narrows, particularly as Houlihan Lokey has recorded valuation declines among smaller borrowers. Second, the non-accrual loan ratio at BDCs and the discount of share prices to NAV. Third, repurchase requests and fulfilment rates at unlisted BDCs in the next quarter. Fourth, the impact of the Fed’s rate path on the interest burden of floating-rate borrowers.