Private Credit Losses Deepen 18% in Q1 as Stress Tests Loom
2h ago|4 min readStandard
Fazen Markets Editorial Desk
Collective editorial team · methodology
private-creditdirect-lending
Fazen Markets Editorial Desk
Collective editorial team · methodology
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Paper losses at major private credit lenders continued to deteriorate in the first quarter of 2026, extending a trend of valuation pressure that began in late 2025. A review of lender filings and fund disclosures by Investing.com on 29 May 2026 showed the average mark-to-market loss across a basket of large direct lending funds deepened to 18% from par, compared to 13% at the end of the prior quarter. The widening gap between private asset valuations and the public leveraged loan market has intensified scrutiny on the $1.7 trillion asset class as systemic risk assessments begin.
The current stress echoes the valuation dislocation of late 2015 to early 2016, when energy sector defaults triggered a 22% peak-to-trough drawdown in second-lien loan prices. The Bank for International Settlements documented that episode as a warning on illiquid credit. Today's macro backdrop is distinct, with the Federal Reserve's key policy rate holding at 4.75% after a prolonged hiking cycle that began in 2022. Benchmark 10-year Treasury yields trade at 4.32%, compressing the yield premium investors demand for private credit risk.
The immediate catalyst for the renewed focus on paper losses is the scheduled commencement of regulator-mandated stress tests for non-bank lenders in July 2026. The Federal Reserve and the Office of the Comptroller of the Currency will require detailed scenario analysis on concentrated loan books. This regulatory pressure is forcing funds to re-evaluate models and mark portfolios more conservatively ahead of the review, accelerating recognition of existing impairment.
The 18% average mark-to-market loss represents a significant discount to the public market. The S&P/LSTA Leveraged Loan Index, a proxy for the liquid market, trades at an average price of 96.5 cents on the dollar, implying a 3.5% loss. This creates a 14.5 percentage point valuation gap between public and private markets for similar corporate credit risk. Individual fund losses show wide dispersion.
The three largest business development companies by assets—Ares Capital (ARCC), Owl Rock Capital (ORCC), and FS KKR Capital (FSK)—reported Q1 net asset value declines of 4.2%, 5.1%, and 6.8% respectively. These figures are net of income, meaning gross markdowns were larger. A sample of fifteen private funds shows three have paper losses exceeding 25% of their portfolio at cost. The table below illustrates the divergence between reported yields and economic reality.
Fund Type | Avg. Reported Yield | Avg. Mark-to-Market Loss
---|---|----
BDC Public | 11.2% | -5.4%
Private Fund | 12.8% | -18.0%
The widening losses create direct pressure on publicly traded BDCs like ARCC, ORCC, and FSK, which may face investor redemptions and higher funding costs. These entities rely on periodic debt issuance and equity raises. Secondary market prices for BDC shares already reflect concern, with the VanEck BDC Income ETF (BIZD) down 14% year-to-date versus the S&P 500's 8% gain. Conversely, the situation benefits distressed debt funds and secondary market buyers like Oaktree Capital Management (OAK) and Apollo Global Management (APO), which are raising capital to acquire discounted loans.
A key limitation is that paper losses are not realized cash losses. Many underlying borrowers continue to service debt, and defaults remain below historical peaks. The counter-argument holds that extended higher rates will eventually trigger a default cycle, turning paper losses into real ones. Current positioning data shows hedge funds have increased short bets against BDCs while large asset managers are accumulating positions in credit default swap indices on leveraged loans, anticipating broader weakness.
The primary near-term catalyst is the release of the Fed's stress test scenarios on 15 July 2026. The severity of the 'severely adverse' scenario for middle-market corporate EBITDA will signal regulatory concern. Second, the Q2 2026 earnings reports for major BDCs, beginning with ARCC on 30 July, will provide updated NAV figures and non-accrual rates. A breach of the 5% non-accrual level at any major lender would signal deteriorating credit quality.
Key levels to monitor include the 200-day moving average for the BIZD ETF, currently at $16.80. A sustained break below this technical support could trigger further institutional selling. In rates, watch the 10-year Treasury yield; a move above 4.5% would pressure refinancing prospects for private credit borrowers and likely widen paper losses further.
Retail investors exposed through BDC stocks or interval funds face potential declines in net asset value and dividends. BDCs must distribute 90% of income as dividends, but if NAV erodes, long-term total returns suffer. Funds may cut payouts if realized losses mount. Retail investors should review fund concentration, default rates, and leverage ratios rather than relying solely on headline yield figures.
The 2008 crisis primarily involved securitized public credit (CDOs, CLOs) and banking system use. Today's private credit market is larger but held by institutional funds, not banks. Losses are currently mark-to-market, not defaults. The 2008 crisis saw realized default rates on leveraged loans peak near 10.5% by 2009. Current default rates in direct lending portfolios are estimated below 3%, though trending up from 1.5% a year ago.
Historical recovery rates for senior secured direct loans have averaged 70-80 cents on the dollar, according to data from the past two decades compiled by Fazen Markets research. This is higher than unsecured high-yield bonds, which average 40-50% recovery. However, recovery assumes an orderly liquidation process. In a systemic wave of defaults with many distressed sellers, recoveries could fall toward 60%, materially impacting fund capital.
Private credit's growing valuation gap signals latent stress that regulatory scrutiny and higher-for-longer rates are beginning to unmask.
Disclaimer: This article is for informational purposes only and does not constitute investment advice. CFD trading carries high risk of capital loss.
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