A sharp divide has emerged across the $1.7 trillion private credit market. While headline default metrics indicate corporate direct lending remains stable, proprietary loan-level data shows distress concentrating among smaller middle-market companies. According to Houlihan Lokey’s Q2 2026 Private Credit DataBank report released on BusinessWire, the share of loans priced below 90% of par climbed to 12% for borrowers with EBITDA between $10 million and $20 million—a tenfold increase from roughly 1% in 2023.
As benchmark borrowing costs hold firm ahead of the September 16 Federal Open Market Committee meeting, this widening performance gap highlights how smaller firms are struggling with floating-rate debt service, even as large-scale enterprise borrowers continue to perform smoothly.
Key Takeaways
- Concentrated Distress: Loans marked below 90% of par reached 12% for borrowers with $10M–$20M EBITDA and 6% for core middle-market firms ($20M–$100M), while upper middle-market companies (> $100M EBITDA) saw just 3%.
- Bifurcated Defaults: Smaller borrowers recorded a 3.0% size-weighted default rate and 3.6% by count in Q2 2026, compared to a full-market size-weighted default rate of only 0.8%.
- PIK Signal Contained: While 11.8% of loans elected payment-in-kind (PIK) interest, actual usage represented only 6.3% of interest dollars. Distress-driven “amended PIK” accounted for just 1.6%.
- Sector Divergence: Healthcare was the only industry elevated on both default count (4.2%) and size-weighted (2.7%) metrics, while software maintained low default rates and 20% EBITDA growth since origination.
The Great Divide: Headline Stability Masks Small-Borrower Strain
For institutional allocators, overall private credit performance appears remarkably steady. Across the direct lending market tracked by Houlihan Lokey, defaults represented just 0.8% of outstanding principal on a size-weighted basis and 2.5% of borrowers by count. However, this macro stability is anchored by jumbo corporate loans that dominate size-weighted indices.
For companies generating less than $100 million in annual EBITDA, credit conditions are far tighter. The default rate among this smaller cohort climbed to 3.0% on a size-weighted basis and 3.6% by borrower count during the second quarter of 2026. The gap demonstrates that credit risk in direct lending is primarily a function of borrower scale.
“Default levels have picked up from recent quarters among borrowers with less than $100 million of EBITDA. That is where much of the direct lending market operates,” noted Dr. Cindy Ma, Managing Director and Global Head of Portfolio Valuation and Fund Advisory Services at Houlihan Lokey. “When one weights the full market by loan size, defaults remain below 1% because the largest borrowers continue to perform. We expect this divide by borrower size to define the market through the balance of the year.”
Valuation Cracks: 7% of All Loans Trade Below 90% of Par
In private debt portfolios, valuation marks offer an early signal of credit stress before formal payment defaults occur. Across all loan categories, 7% of facilities are now marked below 90% of par, more than double historical norms. That discount is heavily skewed toward smaller issuers.
| Borrower Segment (EBITDA) | Loans Marked < 90% Par | Size-Weighted Default Rate | Default Rate by Count |
|---|---|---|---|
| Lower Middle Market ($10M–$20M) | 12.0% | 3.4% | 3.9% |
| Core Middle Market ($20M–$100M) | 6.0% | 2.8% | 3.4% |
| All Small Borrowers (< $100M) | 7.8% | 3.0% | 3.6% |
| Upper Middle Market (> $100M) | 3.0% | 0.4% | 1.2% |
| Full Market Aggregate | 7.0% | 0.8% | 2.5% |
In the core middle market ($20 million to $100 million EBITDA), 6% of credit facilities are now marked below 90% of par, a three-year high. Debt service coverage has narrowed as smaller companies absorb wage pressures and elevated interest rates on debt pegged to SOFR plus 550 to 650 basis points.
The PIK Factor: Structural Feature vs. True Stress
Market observers frequently point to rising payment-in-kind (PIK) interest—where borrowers pay interest via additional debt rather than cash—as a harbinger of distress. Houlihan Lokey’s loan-level analysis challenges that assumption.
While the availability of PIK features touched a record high in June 2026, actual election remained measured. In Q2 2026, 11.8% of loans on a size-weighted basis opted to pay interest in kind, representing just 6.3% of total interest dollars.
More importantly, the DataBank separates standard contractually structured PIK options from “amended PIK,” where the toggle was added after origination to ease sponsor cash strain. Amended PIK accounted for only 1.6% of total interest dollars, demonstrating that distress-driven coupon relief remains contained.
“A PIK option is a structuring feature, and not necessarily a distress signal, and the two get conflated,” said Timothy Kang, Managing Director in Houlihan Lokey’s Portfolio Valuation practice. “The measure we watch is amended PIK, where the feature was added after origination. At 1.6% of interest dollars, that signal remains contained.”
Sector Divergence: Healthcare Under Pressure as Software Proves Resilient
Credit stress varies widely across industries. Healthcare was the sole sector displaying heightened distress across both metrics, posting a 4.2% default rate by borrower count and 2.7% size-weighted. Clinician wage inflation and reimbursement delays continue to strain cash flow for regional operators.
Consumer businesses showed a 3.6% default rate by borrower count, but only 0.7% on a size-weighted basis, indicating that pain is isolated among smaller regional chains rather than large national franchises.
Conversely, enterprise software showed some of the strongest credit health in the DataBank. Median EBITDA among software borrowers is 20% above origination levels, and defaults remain negligible. Across the broader portfolio, median borrower revenue grew 6.5% and EBITDA expanded 7.4% year-over-year, with over two-thirds of companies growing both metrics.
Capital Markets Implications and What to Watch Next
This loan-level bifurcation sheds light on broader alternative investment dynamics. Over the past year, investors have re-evaluated how direct lending differs from syndicated loans as liquidity shifted. While upper middle-market direct lending has remained competitive, lower-tier stress drove earlier redemption caps at major BDCs and prompted the Federal Reserve’s supervisory survey of private credit.
Moving forward, market participants should track three catalysts:
- The September 16 FOMC Decision: Any prolonged higher-rate stance will compound debt service pressure for smaller borrowers with coverage ratios below 1.5x.
- Sponsor Equity Injections: Private equity sponsors will face choices on whether to inject fresh junior capital to cure covenant breaches or cede control to direct lenders.
- Secondary Loan Trading: With 12% of small loans trading below 90% of par, secondary credit funds are actively identifying discounted portfolio acquisitions.
Sources
- BusinessWire: Houlihan Lokey Finds Stress Among Smallest Private Credit Borrowers Climbed More Than Tenfold Since 2023
- Houlihan Lokey Newsroom: Q2 2026 Private Credit DataBank Market Trends & Insights
- Webull Financial News: Houlihan Lokey Private Credit DataBank Overview
Disclosure: This article is for informational purposes only and is not investment advice.