September 21, 2026
Fitch just hit a new default record and some lenders have already quietly priced it in. Others have not.
Hey there, bargain hunter. A $2 trillion market and nobody agrees what is happening inside it. That is the situation with private credit right now, and the gap between the optimists and the pessimists is not rounding error.
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Scoreboard
Fitch Ratings put the trailing 12-month default rate at 6.3% through August 2026, edging up from July’s 6.1% and setting a new high. August alone produced 14 default events, a jump from three in July and the largest monthly count within the current trailing-year window. KBRA’s latest measure also pointed to a new high. Bloomberg noted last week that depending on who you ask, the same market’s default rate is 1%, 6%, or 19%.
What Actually Happened
The dispersion is not dishonesty. It is methodology. Fitch’s private credit default rate blends two measures: a model-based series tracking more than 1,300 credit opinions used in middle-market CLOs, and a privately monitored ratings series covering more than 350 private ratings often used by insurers. Change the sample, change the number. The lenders reporting near-1% defaults are almost always counting only formal payment failures on their own books, excluding restructurings, PIK toggles, and covenant amendments.
The scariest data point is not Fitch. It is the borrower behavior underneath. The Boston Fed documented a steady increase in PIK usage since early 2022. The share of BDC loans with payment-in-kind terms rose from approximately 6% to roughly 10% by early 2026, a 67% increase over three years. PIK means the borrower adds unpaid interest to the loan balance instead of writing a check. It is not default yet. It is a company that cannot cover its interest from operations, which is the definition of pre-default.
This trend appears across nearly every industry in the Boston Fed sample, suggesting the increase in PIK usage cannot be attributed largely to BDCs adding more new companies in growth industries. Spread across the middle market. That matters.
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The Rate-Hike Problem
A floating-rate loan book reprices within a quarter of a hike and the borrower’s ability to service it does not, so the same quarter point arrives as income on one side and as a bill on the other. The income books this quarter. The bill takes two to four quarters to surface as a default, and years to surface as a maturity nobody will refinance.
Morgan Stanley warned direct lending default rates could surge to 8%, well above the 2-2.5% historical average, with pressure concentrated in sectors vulnerable to AI disruption, such as software. Smaller companies showed the highest default intensity, with issuers under $25 million of EBITDA posting a 12.0% trailing-year default rate in August.
Is It Cheap?: Running the NAV Math
BDCs look like a bargain on yield until you check what is behind the coupon. According to LSEG data cited by MarketScreener in April 2026, the median price-to-forward 12-month net asset value ratio for BDCs was about 0.74 at the end of March, implying a discount of roughly 26%. That spread is not uniform, and the difference matters enormously.
- ARCC (Ares Capital, the largest public BDC at roughly $14 billion in net assets): Reports non-accruals at 2.4% at amortized cost and 1.4% at fair value, up from 1.8% and 1.2% at end of December. Trades near 0.95x NAV, a very slight premium to the peer median. The premium is earned: over 600 borrowers, roughly $6 billion in available liquidity, and a dividend held at $0.48 quarterly.
- BXSL (Blackstone Secured Lending): Reported a non-accrual rate of 0.6% on a cost basis at end of 2025, alongside 97.6% of its portfolio in first-lien senior secured loans. Traded around a 10% discount to NAV in April, which looked defensible at that portfolio quality.
- OBDC (Blue Owl Capital Corp): Traded at a discount of approximately 23% relative to its latest NAV estimate. Its traded BDC actually reported non-accruals at just 0.6%, but a proposed merger of OBDC II into the public vehicle at terms that Financial Times coverage described as potentially implying about a 20% haircut for OBDC II investors triggered a class action lawsuit. The discount reflects governance fear as much as credit fear.
- FSK (FS KKR Capital): This one is a warning, not an opportunity. Non-accrual rates escalated to 4.2% fair value (8.1% at cost) by Q1 2026. NII fell below the dividend, forcing a distribution reset. The high yield at FSK is a classic yield trap: the market price decline that inflates the yield reflects genuine credit deterioration, not an opportunity. PIK income comprised about 14.4% of FSK’s June-quarter investment income.
The yield premium BDCs earn for originating private loans over public leveraged loans has compressed from more than 300 basis points in 2017-2018 to under 100 basis points by Q1 2026, as highlighted in recent PIMCO research. You are being paid less to take the same illiquidity risk as defaults climb.
Bull/Base/Bear
Bull: Fed cuts relieve pressure on floating-rate borrowers, PIK migration slows, ARCC and BXSL’s first-lien portfolios absorb the cycle without dividend cuts, and sector-wide discounts to NAV compress as credit stabilizes.
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Base: Defaults settle near Fitch’s current 6.3% reading, healthcare and industrials absorb more pain, weaker BDCs cut dividends again, and discounts stay wide for another 6-12 months while the market waits for NAV marks to reflect reality.
Bear: Morgan Stanley’s 8% direct-lending default forecast proves conservative. The divergence between tightening bank credit supply and increasing BDC demand creates funding pressure that hits BDC borrowing costs before their loan portfolios recover. NAV marks fall materially and the 26% sector discount is still not cheap enough.
Action Plan
On ARCC and BXSL: both have earned their relative standing with first-lien concentration and real liquidity. Small initial positions on dips make sense. Scale in if non-accruals stay below 3% on a cost basis across two more quarterly filings. On OBDC: governance risk is real but the underlying portfolio is cleaner than the share price suggests. Watch the OBDC II situation for resolution before adding. On FSK: the 41% discount is a signal, not a sale. Avoid until NII covers the dividend again. On the asset managers (APO, ARES, BX, KKR, OWL): they collect fees whether or not borrowers pay. Fee-based exposure to private credit is the cleaner way to participate in the sector’s long-term growth without owning the credit risk directly.
Cheap Investor Checklist
- Non-accruals at amortized cost: flag anything above 3% as elevated; above 5% is a dividend risk
- PIK income as a share of total investment income: flag anything above 10%
- NII coverage of the declared dividend: must be at or above 1.0x, not close
- Discount to NAV: distinguish between quality discounts (ARCC near par) and distress discounts (FSK at 41%)
- Software exposure: verify the actual figure, not the BDC-defined sector classification, which can understate it
- Liquidity: undrawn revolver and available leverage headroom against the regulatory 1:1 debt-to-equity limit
- Level 3 asset marks: compare to publicly traded comparable loans, not just prior-quarter internal marks
Bottom Line
If non-accruals stay contained at ARCC and BXSL and the Fed pauses, both names are genuinely cheap relative to the income they generate. If Morgan Stanley is right and defaults approach 8%, the 26% median discount to NAV has more room to widen, and FSK-style dividend resets become the sector story for 2027. The default number you trust should determine how much of this sector you own. Right now, nobody agrees on that number. Size your position accordingly.
