The private credit market is presenting wildly divergent default rate estimates, ranging from under 1% to nearly 19% depending on the source. This staggering discrepancy not only exposes the data transparency challenges of the $1.8 trillion asset class but also complicates risk assessment at a time when retail investors are accelerating their withdrawals.

Fitch Ratings this week raised its private credit default rate to a record 6.3%, while credit rating agency KBRA's latest data also points to new highs. Meanwhile, Pacific Investment Management Company's proprietary "shadow" default rate metric shows that default rates for business development companies (BDCs) catering to retail investors have climbed from approximately 14% in 2022 to 19%.

Investment bank Houlihan Lokey's calculations paint a starkly different picture — when weighted by loan size, the default rate remains below 1%, because the largest borrowers continue to perform solidly. Behind these divergent figures lies growing concern among retail investors about the health of private credit borrowers, with substantial redemption pressures already building. Additionally, the Federal Reserve's unanimous decision on Wednesday to raise interest rates for the first time in over three years could further intensify financing cost pressures on highly leveraged borrowers.

The Data Void: A Structural Defect in Private Credit

The root cause of the widely varying default rate estimates in the private credit market lies in the absence of unified data infrastructure. Unlike public markets, private credit lenders and borrowers operate with far lower levels of information disclosure compared to their public market counterparts. No comprehensive industry-wide dataset currently exists, forcing rating agencies and advisory firms to piece together disparate corners of the market, resulting in vastly different stress estimates.

The discrepancies have grown so significant that institutional investors are now building their own models. Lotfi Karoui, multi-asset credit strategist at Pacific Investment Management Company, notes that "the estimates from various parties could not be more different." Pimco's analysis covers only approximately $500 billion in assets held by US BDCs — a partial slice of the broader market — yet its 19% "shadow" default rate has already attracted significant attention.

Furthermore, there is no consensus on what constitutes a "default." Some institutions use non-accrual loan rates (when loans stop paying interest) as a measure of stress, but Karoui believes this metric may not fully capture the actual breadth of defaults.

The "Bad PIK" Debate: Does Debt Restructuring Mask True Risk?

At the core of the shadow default rate calculation debate lies the treatment of so-called "bad PIK" debt. Payment-in-kind debt refers to arrangements where borrowers substitute new debt for cash interest payments. Pimco's default rate calculations include PIK debt added during the life of a loan — meaning additional debt taken on to ease borrower cash flow pressure, rather than arrangements stipulated in original loan terms.

This type of debt has become a flashpoint of controversy: some argue that using debt to repay debt still constitutes "normal performance," while others contend it is merely a means of concealing deteriorating loan quality. By contrast, Lincoln International reports a European loan default rate of just 1.5%, partly because its methodology excludes such events. Nick Baldwin, managing director at the firm, offers a measured perspective: "From my standpoint, there's no need to sound the alarm — the sky hasn't fallen — but regardless of which metric you examine, we're beginning to see stress building."

In operational terms, institutions also apply different standards for classifying non-accrual loans. According to regulatory filings, Sixth Street Specialty Lending classifies loans as non-accrual when payments are at least 30 days past due, or when management has reasonable doubt about the borrower's ability to repay in full. Hercules Capital employs a different threshold, classifying loans based on whether full recovery is considered unlikely.

Systemic Risk: At What Default Level Does Danger Emerge?

For investors, the more critical question may not be the precise default rate figure, but rather when rising stress begins to erode returns or threaten broader financial system stability. Timothy Rahill, credit strategist at ING Groep NV, suggests that given private credit's inherent focus on highly leveraged borrowers, managers may be able to withstand default rates of 8% to 9%. However, if default rates climb toward 12% to 15% following a major economic shock, "that's when systemic risk questions truly come to the fore."

Research from Credit Benchmark reveals another layer of contradiction: over the past two years, the average risk assessment for BDCs has declined by 5%, while the default risk of their underlying holdings has risen by 12% during the same period. This divergence itself serves as a microcosm of the widening gap between valuations and risk perception in today's private credit market. Highly leveraged companies that financed aggressively during the low-interest-rate era now face financing costs that may remain elevated for an extended period, with inflation and geopolitical risks further clouding the interest rate outlook. Against this backdrop, clarifying the true default levels in the private credit market is no longer merely an academic exercise — it is a practical question directly affecting investors' asset allocation decisions.