Private Credit Is Showing More Signs of Distress

Key Takeaways

• Strains in private credit markets are continuing to grow, and some reporting methods may understate the level of credit deterioration.
• More borrowers are falling into non-accrual status across the largest BDCs and the broader BDC universe.
• Viewing credit quality through a wider lens shows credit stress is wider than the headline numbers suggest, while interest income at risk is rising.

Non-accrual debt—one of a lender’s clearest signals of borrower distress—is rising, and private credit is entering a more challenging phase. While the current impact of interest income could be considered manageable, the direction is a clear signal of rising credit risk.

The private credit industry enjoyed years of strong growth, supported by expanding assets under management, robust investment activity, and attractive returns for investors. But the credit cycle is turning. The latest LCD data suggests that rising borrower distress is becoming a more meaningful feature of the market.

Credit Risk Continued to Build in Largest BDCs During Q2

While not all business development companies have reported second-quarter results, the ten largest publicly traded ones have, providing a useful proxy for the broader market. Analysis of the results confirmed that credit risk continued to build during the latest quarter, with non-accrual exposure increasing across every measure.

At the time of writing, the ten largest publicly traded BDCs by amortized cost of investments are:

• Ares Capital ARCC
• Blackstone Secured Lending Fund BXSL
• FS KKR Capital FSK
• Golub Capital GBDC
• Goldman Sachs BDC GSBD
• Main Street Capital Corp MAIN
• MidCap Financial Investment MFIC
• Morgan Stanley Direct Lending Fund MSDL
• Blue Owl Capital OBDC
• Sixth Street Specialty Lending TSLX

Debt tranches in non-accrual status at the top ten BDCs rose to 3.95% of total debt at cost in the second quarter, up 20 basis points from the prior quarter. The balance increased slightly by $89 million to $3.3 billion despite a 2.3% contraction in the overall debt portfolio, which brought total debt at cost down to $83.6 billion.

Counting all debt tranches (performing and non-accrual) owed by borrowers with at least one non-accrual tranche, exposure at cost reached $5 billion, or 5.95% of total debt in the second quarter—a 54-basis-point increase from the prior quarter. The story is similar by borrower count. The number of distinct borrowers with at least one tranche in non-accrual status rose by 11 over the quarter to 101.

The BDC Universe: Q1 2023 Through Q1 2026

More borrowers have fallen into non-accrual status. The number of borrowers with at least one debt instrument in non-accrual status reached 356 in the first quarter of 2026, representing 4.69% of all borrowers, up from 4.26% a year earlier. This share has risen steadily over the past three years, increasing from 3.69% in the first quarter of 2023.

Non-Accrual Debt Exposure Is Rising

We compare non-accrual metrics on an as-reported basis with those on an adjusted basis. In the adjusted view, we treat a borrower’s entire debt amount (whether it is performing or not) as non-accrual whenever at least one BDC reports at least one of that borrower’s debt instruments to be in non-accrual status. This approach highlights the additional credit risk exposure for BDCs, which as-reported figures alone may understate.

US-registered BDC funds have more than doubled over the past three years to an overall portfolio size of about $516 billion of debt at cost as of the first quarter of 2026. Debt for non-accrual borrowers has more than tripled over that period. The non-accrual share remained within a narrow 1.3%-1.5% band until the first quarter of 2026, when it increased 52 basis points to 1.9% from the previous quarter. In dollar terms, non-accrual debt rose 39% (nearly $2.8 billion) in the first quarter alone, bringing the total to roughly $10.0 billion. This compares with just a 1% increase in total debt investments held by BDCs in the first quarter of 2026 from the prior quarter.

The heightened credit risk exposure is more pronounced when viewed on an adjusted non-accrual basis. In BDC reporting, it is not unusual to see a loan facility from a borrower placed on non-accrual status while another loan in the borrower’s debt structure isn’t. Also, a BDC holding a pro rata share of the same loan might not have it as non-accrual, while another BDC does. These situations could cause the distress in the overall BDC portfolio to be underestimated if only the debt tranche placed on non-accrual is counted. The company itself is in distress, and if it can’t maintain the performance of a particular loan, other debt within its capital structure could also be at risk.

As such, a key aspect of this analysis entails adjusting the definition of non-accrual status to extend it to all debt (performing or otherwise) of a borrower with at least one tranche of non-accrual debt. Under this lens, the distress borne by the non-performing loans extends to the borrower and carries through to the whole debt structure.

From this adjusted angle, non-accrual rates run higher. Over the three years leading up to the first quarter of 2026 (at amortized cost), non-accruals across the BDC universe averaged 2.1% of total debt and stayed within a 2.0%-2.4% range through year-end 2025. In the first quarter of 2026, however, the rate jumped to 3.3%—up 116 basis points from the prior quarter and 130 points from the year-ago period.

From a dollar perspective, the increase is even more striking. Adjusted non-accrual loans rose $6.1 billion to $17.3 billion as of the first quarter of 2026—$7.3 billion more than the $10.0 billion in reported non-accrual debt. Two borrowers, Medallia and Inovalon, accounted for $4.4 billion of the non-accrual total.

Interest Income at Risk is Climbing

While borrowers could continue to pay interest on debt designated as non-accrual by the lender, the investments are more often non-performing loans and in default or forbearance, with a likelihood of at least a partial loss for lenders. Any amount collected would accrue toward loan loss reserves.

If a borrower can’t remain current on one loan, it likely cannot do so on its other debt. As such, if we consider the interest at risk on other debt held by BDCs, in the aggregate, they carry a risk of $772 million in interest that could imminently be in default.

As of the first quarter of 2026, about $522 million in cash interest income is directly attributable to non-accrual loans, representing about 138 basis points of $38 billion total cash interest income across all BDCs. Together with the additional $249 million in at-risk interest income from the adjusted method, the total interest exposure amounts to the aforementioned $772 million, or about 204 basis points of the total cash interest income. This means the total cash yield would fall to 8.1% from 8.3% for the first quarter.

Note that this calculation only accounts for tranches that report interest income. Of the $9.1 billion of debt (at principal) belonging to non-accrual borrowers, only $7.6 billion reports interest rates. The rest are reported with no interest rate.

The cash income at risk is small, at about 2% of total cash interest income, which seems low mainly because much of the debt owed by non-accrual borrowers (those with at least one tranche on non-accrual) is payment-in-kind. As such, it does not show in the cash interest income figure. Counting both cash and non-cash income, the amount at risk is much higher.