October 16, 2026
Private Credit Markets – Q3 2026 Update
If there was one word that defined the third quarter, it was rates.
We came into July with risk markets back to near highs and the debate still centered on when the Fed would cut. We left September with the Fed hiking for the first time since 2023, the 10-year Treasury at its highest close since 2002, and oil up roughly 30% on the quarter.
And yet, on the surface, not much broke. The S&P 500 finished modestly higher. High-yield spreads widened, but not dramatically. Leveraged loans had their best quarter in more than a year.
Underneath, though, the market split. Quality got paid. Leverage got punished. That theme ran through equities, public credit, and private credit alike.
THE MACRO PICTURE: THE FED PICKS A SIDE
The summer started with a ceasefire framework in the Middle East and some hope that energy prices would settle. By mid-August, that framework had stalled, traffic through the Strait of Hormuz remained constrained, and oil moved sharply higher again. West Texas Intermediate ended the quarter around $91 and Brent near $101.
Inflation followed. Headline CPI eased from its May peak of 4.1% but was still running at 3.4% in August. Meanwhile, the data refused to roll over. Unemployment held at 4.2%, payroll gains slowed but stayed positive, and the consumer kept spending despite sentiment readings near record lows.
That combination gave the Fed cover to act. On September 16, the FOMC raised rates by 25 basis points to 3.75%–4.00%, unanimously, and the dot plot points to one more hike this year. Markets now treat a second hike in December as highly likely, and most of that is already in the price.
The bond market did the rest. The 10-year Treasury rose more than 80 basis points during the quarter to roughly 5.28%, touching its highest level since 2002. The 2-year rose about 70 basis points to 4.89%.
We said last quarter that we believed policy was already restrictive, and we still do. The energy shock tightens financial conditions on its own, through higher costs and weaker purchasing power. Layering rate hikes on top of that risks compounding the damage, particularly for floating-rate borrowers.
The bigger question is 2027. If the Fed keeps going, the pressure builds quietly on floating-rate borrowers, one coupon reset at a time. We still don’t think it’s the right call, but we are underwriting as if it happens.
RISK ASSETS: UP, BUT NOT BY MUCH, AND NOT FOR EVERYONE
U.S. equities ended the quarter modestly higher. The S&P 500 returned about 2.3% and is up 12.7% for the year. The Nasdaq gained roughly 2.6% and is up 16.1% year to date.¹
The headline hides how narrow the gains were. A handful of mega-cap names did most of the work, adding close to $3 trillion in market value, while the rest of the S&P 500 drifted lower. Small caps had a rough quarter, with the Russell 2000 down more than 7%. The Dow lost about 2%.
Sector performance followed oil and rates. Energy was the clear winner. Rate-sensitive areas, utilities in particular, were the worst performers. Semiconductors gave back some of their earlier gains as AI sentiment swung back and forth.
Internationally, results were mixed. Developed markets were roughly flat in dollar terms and emerging markets slipped, though both remain comfortably ahead for the year.
Commodities split as well. Oil was up roughly 30% for the quarter. Gold was volatile, surging in August before giving most of it back in September, and finished only modestly higher at around $4,180 an ounce.¹
Credit and equities also told different stories. Into early October, the S&P 500 sat within about 1% of its highs while credit, rates and oil all showed real stress.⁸ One of them will likely have to give.
The message from risk markets was not “risk off.” It was “be selective.” Investors kept buying, but they paid up for earnings, balance sheets and pricing power, and sold what depended on cheap money.
PUBLIC CREDIT: THE INDEX HELD, THE TAIL DIDN’T
Fixed-rate credit had a tough quarter, mostly because of rates rather than credit. Investment grade lost more than 4% in Q3 and is now down over 3% for the year. High yield lost about 1.8% in the quarter, with a 2.5% drop in September alone, nearly wiping out its gains for 2026.²
That says as much about what investors own as it does about credit fundamentals. Spreads now make up less than 15% of the all-in yield on investment grade, versus about 45% in 2019–2021, and just over a third in high yield.⁸ Public credit buyers are mostly buying Treasury yield with a thin layer of credit spread on top.
Spreads widened, but only modestly at the index level. Investment-grade spreads moved out about 8 basis points to roughly 84. High-yield spreads widened 37 basis points to about 312, with the index yield up more than a full percentage point to 8.3%.³
The more important story was beneath the surface. BB and single-B spreads moved wider at a measured pace. CCC spreads, by contrast, blew out to roughly 1,000 basis points, the widest in over a year.⁴ Higher base rates are doing exactly what you would expect: putting the most pressure on the most leveraged capital structures. Fundamentals tell the same story. Median earnings in high yield and loans actually improved in the second quarter, but interest coverage among CCC-rated bond issuers fell to its lowest level on record.⁵
Leveraged loans: floating rate finally paid. Loans returned about 2% in Q3, their best quarter since Q2 2025, and are up roughly 3.3% for the year. Collateralized loan obligation issuance rebounded to $45.8 billion and demand outran net new supply by about $39 billion.²
But lenders were picky. Nearly half of this year’s M&A loan volume has gone to borrowers rated BB-minus or better, the highest share since the financial crisis. Only 14% went to B-minus borrowers, a 14-year low. Software, which dominated leveraged lending for a decade, has fallen to about 10% of new issuance.²
The 2028 maturity wall is where this gets real. Roughly 62% of the $152 billion of loans due in 2028 sits with B-minus or lower-rated borrowers. Those that refinanced this year paid, on average, more than they did on the original loan. The spread gap between B-minus and BB-minus new issues has nearly doubled, to around 190 basis points.²
High yield: AI takes the wheel. After a quiet summer, September issuance surged to $50 billion, led by record deals for SoftBank’s investment in OpenAI and Paramount Skydance’s acquisition of Warner Bros. Discovery. High-yield bonds raised for AI and data center expansion have reached $37.6 billion this year, versus a prior annual peak of $4.5 billion. Several of those bonds are already trading well below issue price.² Paramount’s $12.4 billion second-lien bonds fell 4–6 points within days of pricing despite strong order books, a reminder that a full book doesn’t guarantee support once the bonds start trading.⁸
We believe the message is consistent with last quarter: public credit markets are open, but they are pricing quality, not just risk. Strong borrowers can still choose their market. Weaker ones are paying up, or waiting.
PRIVATE CREDIT: THE STRESS IS SHOWING UP IN THE MARKS
Private credit had a quieter quarter on the deal side and a noisier one on the credit side.
New leveraged buyout (LBO) activity stayed subdued. Direct lending backing buyouts totaled about $10.7 billion across 47 deals in Q3, down from $13.5 billion in Q2 and roughly $27 billion a year ago.² At the same time, the syndicated loan market took back a record $16.4 billion of direct lending loans through refinancings, largely the higher-quality names that could get cheaper money elsewhere.2, 6 With fewer deals to go around, competition for non-software credits has pushed spreads back below SOFR+500 in parts of the larger market.
The more important development was in credit quality. Among the 15 largest BDCs, debt marked below 80 cents on the dollar rose 64% over the past year, to $6.8 billion. Nearly 10% of their portfolios is now tied to borrowers with at least one distressed position, roughly double the headline figure.⁶ Software and second-lien loans account for most of the deterioration, but the stress isn’t limited to software. One large healthcare borrower, Affordable Care, completed a restructuring that cut its debt by about 65% and handed ownership to its private credit lenders.²
The distress also isn’t evenly spread by size. One recent industry analysis found roughly 12% of borrowers with under $20 million of EBITDA had loans marked below 90 cents, compared with about 3% for larger companies.² That is a reminder that the lower end of the market is not automatically safer. What matters is how the loans were underwritten and structured.
On the retail side, redemption pressure eased somewhat but remains elevated. Requests at several of the largest non-traded BDCs fell or held steady in Q3, but many are still above their 5% quarterly caps.² Institutional fundraising, meanwhile, remains strong, but it is increasingly concentrated in the largest managers.
We believe all of this reinforces a point we have made for several quarters: private credit is not one asset class. Dispersion is increasing, and we can now see the gap between disciplined underwriting and everything else, clearly visible in the numbers.
Private equity, for its part, showed some signs of healing. Exit value rose 50% from Q2, but the number of exits barely moved. A handful of mega-deals, largely sold to strategic buyers, did most of the lifting.⁹ Distributions are improving at the margin, not broadly, and LPs are still rewarding managers who have actually returned cash. That matters for lenders: sponsors with slower exits hold companies longer, which puts a premium on lenders who can stay alongside them.
WHY WE STILL LIKE THE LOWER MIDDLE MARKET
WWhile large-cap private credit spent the quarter competing with the syndicated market on price, the lower middle market continued to operate on its own terms. Industry reporting described it as a pocket of steady activity, with lenders citing lower software exposure, stronger covenants, and more business-to-business and industrial borrowers.²
Pricing reflects that. Middle market spreads have generally ranged from SOFR+475 to SOFR+525, with some transactions well above that.⁷ Lenders focused on the smallest companies report spreads of SOFR+575 to SOFR+700 at leverage of 2.5x–4.5x.² Compare that with the large-cap market, where a majority of direct lending LBOs this year priced below SOFR+500.²
In a rising-rate environment, the structural differences matter more, not less. Lower leverage means more room to absorb higher interest costs. Maintenance covenants give lenders an early seat at the table when performance slips. Smaller lender groups mean faster, more direct decisions when they do.
We are also seeing more interest in the space. Larger platforms are building out lower middle market teams, and some spreads have compressed as a result.² We think that is worth watching, but the segment remains far less crowded than the parts of the market where most new capital is going.
PUTTING IT ALL IN CONTEXT
Q3 didn’t break anything. But it changed the math.
With the Fed hiking, the 10-year yield above 5%, and oil near $90, the cost of carrying leverage went up for everyone at once. Strong borrowers can absorb that. Weaker ones are starting to show it, in CCC spreads, in BDC marks, and in what it costs to refinance the 2028 maturity wall.
We expect that divergence to continue. More rate hikes may be coming, inflation is proving sticky, and the next leg of credit stress is more likely to come from higher interest costs than from a sudden shock.
In that kind of market, we believe the advantage goes to lenders with conservative leverage, real covenants, and direct relationships with their borrowers. That has always been the case for the lower middle market. This quarter just made it easier to see.
Footnotes:
1. Morgan Stanley, US Corporate Credit Strategy Chartbook, October 2026; CreditSights, The US Almanac Q3-2026. Data as of September 30, 2026.
2. PitchBook | LCD, US Credit Markets Quarterly Wrap, Third Quarter 2026.
3. CreditSights, The US Almanac Q3-2026.
4. Morgan Stanley, US Corporate Credit Strategy Chartbook, October 2026.
5. Morgan Stanley, US Credit Strategy: 2Q26 Fundamentals; CreditSights, US HY vs Leveraged Loan Comparison (2Q26).
6. PitchBook | LCD, US Private Credit & Middle Market Weekly Wrap, October 1, 2026.
7. PitchBook, Private credit lenders finding opportunities in lower middle market, July 2026.
8. Goldman Sachs, Macro Credit Views, October 8, 2026; Goldman Sachs, What’s Trending Across Credit, October 4, 2026.
9. PitchBook, Q3 2026 US PE Breakdown.