Private Credit Risk: Look Past the Default Rate

Key Takeaways

• Default rates alone hide true credit risk exposure
• Loss‑given‑default drives portfolio losses more than default frequency
• Illiquid loan structures increase recovery uncertainty
• Investors need granular loss metrics for pricing and allocation

Pulse Analysis

Private credit has become a cornerstone of institutional portfolios, offering higher yields than traditional bonds. Because these loans are often bespoke and ill‑liquid, market participants have traditionally used default rates as a proxy for risk, assuming that fewer defaults mean safer assets. However, this metric can be misleading; a handful of defaults with deep principal losses can erode returns just as much as a higher frequency of shallow defaults. The Aksia‑Calamos paper highlights this blind spot, urging investors to look beyond headline default numbers.

The crux of the argument centers on loss‑given‑default (LGD), the percentage of principal that investors fail to recover when a borrower defaults. In private credit, LGD can be amplified by complex covenant structures, limited collateral, and the difficulty of executing recoveries in a private‑market context. Even when default rates hover below 2%, LGD can exceed 40% on those events, turning a seemingly low‑risk exposure into a significant loss driver. The paper cites recent distressed deals where recovery rates lagged far behind public‑market expectations, underscoring the need for granular loss analysis.

For practitioners, the takeaway is clear: risk models must integrate detailed LGD assumptions and stress‑test recovery scenarios. Portfolio managers should diversify across loan types, monitor covenant quality, and demand transparent loss‑scenario reporting from fund managers. By shifting focus from default frequency to principal loss potential, investors can better price risk, allocate capital, and safeguard returns in an expanding private‑credit landscape.