Private Credit Defaults Accelerating, Led by Distressed Exchanges

Over the past year, the number of payment-in-kind and “deferred interest schemes” among distressed middle-market borrowers has materially increased, driving an acceleration in default rates, according to an analysis by Morningstar DBRS.

Overall, distressed exchange transactions now “dominate” default activity, accounting for 94% of downgrades to D (default) or SD (selective default) during the 12 months ending February 2026, wrote Candice Gao and Michael Dimler in a March 19 market note. The ratings group recorded 17 private credit rating downgrades to D or SD during that period.

“We believe the rising prevalence of distressed exchanges primarily reflects increased use of interest deferrals as a late-stage tactic among borrowers to avoid hard payment defaults and conserve liquidity after less severe capital support measures were attempted and were unsuccessful,” Gao and Dimler wrote. For example, such a distressed exchange could involve a borrower restructuring its loans to defer all cash interest until maturity without compensating lenders with offsetting interest margin or a principal paydown.

Such a payment deferral generally occurs in the later stages of financial stress, and after lenders or sponsors have attempted to provide borrower support, DBRS said. In practice, these measures are “rarely effective” at staving off defaults, and they can lead to material economic losses for debtholders.

More defaults are coming from the 2021 and 2022 vintages compared with earlier periods, the analysts noted. The ratings group has also begun to see defaults among 2023 vintage borrowers, while defaults among pre-2021 vintages appear to be moderating.

“We expect the recent accelerated pace of default to continue into 2026, following a 78% year-over-year increase of default events in 2025,” said DBRS. “We expect a high proportion of borrowers currently rated in the CCC through C categories (16% of current active credit ratings) to weaken further, particularly those that have relied on waivers or amendments that loosened covenant thresholds or required external capital support.”

Read the full report: Private Credit Default Momentum Increasingly Tied to Distressed Debt Exchanges.