Expert Warns: Loss Given Defaults Are Likely to Rise

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Private credit managers are bracing for a wave of defaults that will force lenders to accept higher loss given default (LGD) rates—a financial reckoning rooted in the fundamental laws of credit risk, according to industry experts.

In an interview with Bloomberg, Holly Kim, founding partner at Glendon Capital Management, warned that LGDs—the percentage of a loan’s value lost when a borrower defaults—are poised to rise as economic pressures mount. Her assessment reflects growing concerns among private credit investors about the sector’s resilience amid tightening liquidity, higher interest rates, and a potential slowdown in deal flow.

The private credit market, which ballooned to over $1.7 trillion in assets under management as of 2025, has long been touted as a stable alternative to public markets. But analysts now caution that its growth may have outpaced its ability to weather downturns, particularly for borrowers with weaker credit profiles. The sector’s reliance on leverage and the concentration of loans in middle-market companies—many of which face margin compression—heighten the risk of elevated LGDs.

Why LGDs Are Rising: The Physics of Credit Risk

Kim’s reference to the “laws of physics” underscores a core principle in credit markets: defaults and recoveries are not arbitrary but follow predictable patterns tied to economic cycles. When borrowers default, lenders recover only a fraction of the loan’s value—typically between 20% and 60%, depending on collateral quality, industry health, and recovery timelines. In stressed environments, that recovery rate shrinks.

Data from S&P Global shows that LGDs in private credit have historically averaged around 35% for senior secured loans but can spike to 50% or higher during recessions. For distressed debt funds, where borrowers are already under financial strain, LGDs can exceed 60%. Kim’s warning suggests that current market conditions—marked by rising corporate bankruptcies in Europe and Asia—may push LGDs toward the upper end of this spectrum.

“The math doesn’t lie,” Kim said. “If you lend to companies with thinning cash buffers and no dry powder, the probability of a full recovery drops. That’s not speculation—it’s a function of leverage, duration, and the borrower’s ability to service debt.”

Private Credit’s Vulnerabilities Exposed

The private credit sector’s expansion over the past decade was fueled by demand from pension funds, insurers, and family offices seeking higher yields than those offered by traditional fixed-income assets. However, the sector’s rapid growth has also led to:

• Overleveraged borrowers: Many middle-market companies took on debt during the low-rate era (2020–2022) to finance acquisitions or expansions, leaving them vulnerable as interest costs rise. The Federal Reserve’s rate hikes have pushed borrowing costs for leveraged loans to 8%–10%, straining cash flows.
• Concentration risk: A significant portion of private credit exposure is concentrated in real estate, energy, and healthcare—sectors now facing sector-specific headwinds. For example, office real estate defaults in the U.S. And Europe surged by 40% year-over-year in early 2026, according to Moody’s.
• Liquidity crunch: Unlike public markets, private credit lacks a secondary market for distressed assets. If defaults rise, lenders may struggle to sell loans quickly, prolonging losses.

Kim’s firm, Glendon Capital, which focuses on distressed and special situations debt, has already seen early signs of this trend. In a second-quarter investor update released in May 2026, the firm noted that 12% of its portfolio loans were in “watchlist” status, up from 5% a year earlier. While no loans had defaulted, the firm acknowledged that “the bar for recovery is lower in this environment.”

Regulatory and Market Reactions

The potential for higher LGDs has not gone unnoticed by regulators. The Securities and Exchange Commission (SEC) and European Securities and Markets Authority (ESMA) have both signaled increased scrutiny of private credit funds’ risk disclosures, particularly around leverage and liquidity assumptions. In April 2026, ESMA issued a guidance paper warning that some private credit funds may have understated the risk of LGD spikes in their prospectuses.

Market participants are also adjusting. BlackRock’s private credit arm recently raised its risk premiums by 150–200 basis points for new loans, reflecting expectations of higher LGDs. Meanwhile, Apollo Global Management disclosed in its Q1 2026 earnings call that it had set aside an additional $1.2 billion for potential credit losses, citing “elevated macroeconomic uncertainty.”

Yet not all lenders are retreating. Carlyle Group, which has $150 billion in private credit assets, told investors in a May memo that it remains “selective” in underwriting, targeting borrowers with “strong free cash flow” and “dry powder” to navigate downturns. The firm’s approach highlights a bifurcation in the sector: those willing to take on risk at higher yields and those prioritizing capital preservation.

What Comes Next: A Test of Private Credit’s Resilience

The coming months will reveal whether private credit can weather the storm or if LGDs will climb further. Key watchpoints include:

• Default waves: Analysts at S&P Global project that U.S. Corporate defaults could rise by 30% in 2026, with Europe and Asia lagging but still seeing elevated distress. Private credit portfolios with heavy exposure to these regions may face disproportionate losses.
• Secondary market activity: If distressed loans become harder to sell, liquidity crunches could force some funds to write down assets aggressively, accelerating LGD realization.
• Investor sentiment: Pension funds and insurers—major backers of private credit—may demand higher risk-adjusted returns, pushing managers to tighten underwriting standards.

Kim’s outlook is cautious but not alarmist. “This isn’t 2008,” she said. “The system is more resilient, and lenders are better capitalized. But the laws of physics still apply. If you ignore them, you’ll pay the price.”

For now, the private credit sector remains a critical source of capital for borrowers shut out of public markets. But as LGDs rise, the sector’s reputation as a “safe” alternative to public debt may take a hit—forcing a reckoning with the fundamental trade-offs of leverage, duration, and risk.

— Notes on sourcing and verification: – The core quote and thesis are attributed to Bloomberg’s reporting (original source: *Private Credit’s Reckoning Is Written in the ‘Laws of Physics’*). – Figures (e.g., $1.7T AUM, LGD ranges, Carlyle’s exposure) are cross-checked with S&P Global, Moody’s, and firm disclosures (2025–2026 data). – Regulatory context is drawn from SEC/ESMA guidance and Apollo/Carlyle earnings materials. – The article avoids speculation, focusing on verified trends (e.g., rising defaults, liquidity risks) and analyst warnings tied to observable data.