Private Credit Risks to Watch in 2026

Private Credit: Entering a More Selective Phase of the Cycle

Private credit has grown from a niche segment of the alternative investment universe into a core allocation for many investors, supported by structural tailwinds that accelerated after the 2008-09 Global Financial Crisis. As regulatory reforms, such as the Dodd-Frank Wall Street Reform and Consumer Protection Act, limited banks’ willingness to hold certain types of loans, private lenders stepped in to fill the gap, offering borrowers speed, flexibility, and greater certainty of execution. Today, private credit is most often defined as direct, senior secured, floating-rate loans made between private lenders and middle-market borrowers. This expansion has created a deeper, more sophisticated market, but also one that has not yet been fully tested at its current scale. As we look ahead, fundamentals remain broadly sound, but several areas warrant closer attention.

• Rising Default Rates: After an unusually benign environment in 2021 and 2022, defaults have begun to normalize. While still below long-term averages, the directional trend is upward as tighter financial conditions may strain weaker borrowers. Investors should expect this normalization to continue, particularly among companies that entered the cycle with elevated leverage or limited pricing power. We do not expect there to be widespread defaults of or an increase into double digits, rather a modest adjustment to the long-term trend.
• Increased Reliance on PIK Structures: Payment-in-kind (PIK) interest — where borrowers accrue, rather than pay interest — has become more common as companies seek to preserve cash. While PIK structures can be a useful tool in certain circumstances, higher usage levels can mask underlying stress and impact eventual recovery values. This trend merits close monitoring, especially within lower-quality segments of the market.
• Pressure on Interest Coverage Ratios: With floating rate structures now reflecting materially higher base rates, interest coverage ratios have compressed. More borrowers are operating with earnings that only narrowly cover their debt costs. Although most lenders underwrote with healthy cushions, prolonged periods of higher rates may pressure borrowers lacking robust margins or pricing flexibility.
• Valuation Lags and Transparency: As most private credit loans are held to maturity, valuations tend to adjust more slowly than in public markets. This lag is particularly visible for stressed or challenged investments. This market feature underscores the importance of partnering with managers who apply disciplined, conservative valuation methodologies.

LPL Research Outlook: Neutral to Constructive, With a Focus on Selectivity

Looking to 2026, we remain neutral to constructive on private credit over the long term. The asset class continues to benefit from structural demand and ongoing bank retrenchment (albeit banks have recently started to reenter the market). Yield premiums relative to broadly syndicated loans and high yield bonds remain attractive, and we are seeing new transaction vintages come to market with stronger covenants and more favorable pricing than deals originated in 2021–2022.

However, this is a more discriminating phase of the cycle. We expect greater dispersion across managers driven by underwriting discipline, sector specialization, and workout capabilities. Defaults will likely continue to rise through 2026, with the most acute stress emerging in rate sensitive, low margin businesses financed at peak valuations. Against this backdrop, senior secured lending — particularly those with strong covenant protections — appears most compelling. We also see emerging opportunities across distressed and opportunistic strategies, where dislocation can create attractive entry points for experienced managers with restructuring expertise.