Private credit shows more signs of financial stress than headline default rates suggest, according to a new PIMCO analysis, which found that distress in direct lending portfolios has risen significantly since 2022, even as the deterioration has recently begun to level off.

Lotfi Karoui, PIMCO’s multi-asset credit strategist and co-head of client solutions and analytics, authored the analysis, which highlights a growing challenge for investors trying to compare private credit with more transparent public debt markets: Borrowers in private markets can often restructure troubled loans without triggering the formal default classifications used in public markets.

"Defaults are not created equal," Karoui wrote, noting that while default rates remain important for assessing credit quality, "headline comparisons between public and private markets can be misleading."

PIMCO’s analysis found that its "shadow default" measure for business development companies, or BDCs, rose from roughly 14% in 2022 to 19% as of March 31, 2026. The measure captures a broader range of events that can signal financial distress, including payment defaults, non-accruals, post-origination cash-to-PIK conversions, significant maturity extensions and debt-to-equity swaps.

The findings suggest that the health of private credit portfolios may be weaker than traditional default statistics indicate.

In public debt markets, defaults are generally easier to identify. Rating agencies typically classify borrowers based on observable events such as missed payments, bankruptcies or distressed exchanges. Private loans, however, are frequently held by a single lender or a small group of lenders, allowing problems to be addressed through negotiated agreements.

Those arrangements can include waivers, maturity extensions or converting cash interest payments into payment-in-kind, or PIK, interest. While economically similar to distressed exchanges in some cases, such transactions are not always classified as defaults.

"The shadow default signal is mixed," Karoui said. His analysis found that financial distress in direct lending portfolios has "risen meaningfully since 2022," although the deterioration has recently begun to plateau.

Karoui’s analysis then compared the private-credit measure with default rates in high-yield bonds and broadly syndicated loans. While PIMCO cautioned that the comparison is imperfect because of differences in borrowers, instruments, disclosure practices and methodologies, it said the data point to a notable divergence.

"Direct lending is leading the downward cycle for now," Karoui wrote, arguing that credit stress appears to be building faster in direct lending than in high-yield bonds.

PIMCO said the bulk of the default events captured by its shadow measure were "soft" forms of distress, including debt-to-equity swaps, maturity extensions and post-origination cash-to-PIK conversions.

High-yield bonds, by contrast, appear better positioned partly because the market’s credit quality has improved since the global financial crisis. PIMCO said changes in the composition of the high-yield market have left it with unusually high credit quality by historical standards.

The findings underscore a broader issue for private-credit investors as the asset class continues to mature. A loan that avoids a formal default may still reflect meaningful deterioration in a borrower’s financial position.

For investors, that means headline default rates may provide only part of the picture. Karoui’s analysis suggests that tracking the ways lenders renegotiate troubled loans could provide a more complete view of stress building beneath the surface of the private-credit market.

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