Private Credit Market Update: Q1-2026
Q1-2026 Market Update
The first quarter of the year was characterized by a volatile and more uncertain backdrop mainly due to broader concerns around geopolitical tension, commodity prices and the potential for artificial intelligence (“AI”) disruption across a range of industries. Private credit saw a multi-year peak in investor redemption requests from retail-oriented structures, notably U.S. Business Development Companies (“BDCs”). As certain pockets of private credit capital contend with liquidity management, institutional investors with consistent asset allocations stand to benefit from more favourable supply and demand dynamics. Periods of broader disruption may create fertile opportunities for long-term private capital to take share on attractive terms and at wider spreads.
Against this backdrop, the following key trends shaped the private credit market in Q1:
While U.S. base rates remained relatively flat over the quarter, the forward curve has shifted upward due to elevated inflationary pressures.
Credit spreads remain tight relative to long-term averages though the market is beginning to increase the price of risk.
Supply and demand dynamics are evolving. Heightened volatility is moderating overall market activity while simultaneously providing more favourable negotiating dynamics for well-capitalized lenders.
Borrower performance has been resilient overall, with some isolated areas of weakness and a heightened focus on potential AI-driven disruption.
While U.S. base rates remained relatively flat over the quarter, the forward curve has shifted upward due to elevated inflationary pressures.
During the quarter, the Federal Reserve (the “Fed”) held its target range for the federal funds rate steady at 3.50% to 3.75%1, noting elevated inflation pressures and geopolitical uncertainty. This guidance contributed to a more hawkish forward curve, with market participants now projecting that interest rates will remain higher for a longer period than previously expected and limited easing priced in for 2026. Current market projections imply an average base rate of ~3.5%2 over the remainder of 2026 to 2028, approximately 20 basis points higher than expectations last quarter (see Figure 1).
Figure 1: Projected U.S. Base Rates
April 2026 to December 2028
Source: Chatham Financial. 3-month SOFR forward curve as of April 1, 2026, and Fed projections as of March 23, 2026. There can be no assurance that any of these projections will be validated by actual events.
Credit spreads remain tight relative to long-term averages though the market is beginning to increase the price of risk.
The ongoing market volatility and risk-off sentiment is leading to early signs of repricing in the credit markets with spreads on broadly syndicated and high yield loans widening by ~15-30 basis points on new issues from Q4-2025 to Q1-2026 (see Figure 2). Spreads in the private credit market adjust slower with transactions already in progress continuing to close at pre-agreed terms, although we have seen new loans price ~25 basis points higher. Combining current base rates and spreads, direct lending continues to generate high single-digit unlevered asset returns, an attractive premium relative to public credit markets. As we look ahead, the combination of interest rates remaining elevated and potentially widening spreads presents an attractive outlook for gross private credit yields.
Figure 2: Private Credit Provides an Attractive Return Premium
Direct Lending Source: Cliffwater LLC. All Rights Reserved. Reproduced with permission. Broadly Syndicated Loans and High Yield Source: Pitchbook. Data through March 31, 2026. Quarterly figures calculated as a 3-month average.
Supply and demand dynamics are evolving. Heightened volatility is moderating overall market activity while simultaneously providing more favourable negotiating dynamics for well-capitalized lenders.
Periods of market volatility typically see banks and liquid credit markets retrench, with private equity sponsors turning to private credit for greater execution certainty. At the same time, elevated redemptions in retail-oriented vehicles have led some large private credit lenders to moderate investment activity, contributing to more attractive supply and demand dynamics for well-capitalized lenders backed by institutional capital.
U.S. M&A/LBO deal volumes in Q1-2026 increased by more than 30% relative to the same period last year, while activity in Europe remained relatively flat (see Figure 3 and 4), however, transaction count declined over the same period, reflecting fewer but larger transactions. While overall LBO deal volumes have been relatively flat in Europe and modestly higher in the U.S. on a YTD basis, first quarter activity has been slower than market participants anticipated at the end of 2025. Sponsors and advisors are prepared to bring select assets to market, but few are rushing to launch sale processes amid ongoing market volatility. This is not dissimilar to what we saw in 2025, where the first half of the year experienced slower volumes due to “Liberation Day”, followed by an increase in activity in the second half of the year.
Figure 3: Momentum in M&A/LBO Volumes
Figure 4: Momentum in M&A/LBO Volumes
Source: Pitchbook/LCD. Data through March 31, 2026. U.S. direct lending estimated volumes, LBOs.
Source: Pitchbook/LCD. Data through March 31, 2026. Europe direct lending estimated volumes, LBOs.
Borrower performance has been resilient overall, with some isolated areas of weakness and a heightened focus on potential AI-driven disruption.
Recent headlines have drawn attention to private credit, but we do not believe they indicate broader systemic stress. Borrower fundamentals remain resilient, with current default rates broadly in line with long-term averages. That said, greater bifurcation in credit performance is likely to drive a modest increase in defaults from historically low levels, with KBRA projecting the annualized default rate to rise from 1.5% in 2025 to 2.0% by year‑end3. Currently, credit risk remains largely idiosyncratic, with pockets of pressure in select sectors (e.g., consumer), certain vintage years (notably 2021), and business models more exposed to AI‑related disruption.
The information technology (“IT”) sector, historically a strong performer, experienced a sharp public market selloff in Q1-2026 amid concerns that AI may weigh on growth and valuations. While lower valuations have increased loan-to-value (“LTV”) ratios, IT loans have historically been underwritten at more conservative LTVs, providing meaningful downside protection. We believe companies with deeply embedded products, high switching costs, and exposure to low cyclicality end markets remain more resilient, while AI is also creating opportunities for well positioned borrowers—particularly those backed by experienced private equity sponsors—through productivity gains and cost efficiencies.
This environment reinforces the importance of partnering with managers that have demonstrated experience through cycles, disciplined underwriting, active portfolio construction, and strong sponsor alignment.
Mid-market private credit continues to remain resilient and provide investors with attractive risk-adjusted returns and contractual cash yield. Against a backdrop of higher market volatility and uncertainty, experienced managers with differentiated sourcing abilities, consistent underwriting and an active approach to portfolio construction and risk management are expected to outperform.
Endnotes:
Unless otherwise indicated, all figures and metrics are in USD and as at December 31, 2025.
Cliffwater,” “Cliffwater Direct Lending Index,” and “CDLI” are trademarks of Cliffwater LLC. The Cliffwater Direct Lending Indexes (the “Indexes”) and all information on the performance or characteristics thereof (“Index Data”) are owned exclusively by Cliffwater LLC, and are referenced herein under license. Neither Cliffwater nor any of its affiliates sponsor or endorse, or are affiliated with or otherwise connected to, Northleaf Capital Partners, or any of its products or services. All Index Data is provided for informational purposes only, on an “as available” basis, without any warranty of any kind, whether express or implied. Cliffwater and its affiliates do not accept any liability whatsoever for any errors or omissions in the Indexes or Index Data, or arising from any use of the Indexes or Index Data, and no third party may rely on any Indexes or Index Data referenced in this report. No further distribution of Index Data is permitted without the express written consent of Cliffwater. Any reference to or use of the Index or Index Data is subject to the further notices and disclaimers set forth from time to time on Cliffwater’s website at https://www.cliffwaterdirectlendingindex.com/disclosures.
- Source: Federal Open Market Committee (FOMC) March 2026.
- Source: Chatham Direct. Represents simple average of 3 month term SOFR forward curve as of April 1, 2026. Data from April 2, 2026 through to December 2028.
- Source: KBRA DLD Default Research. Figures are based on total volume of issuance for all direct lending transactions.
Important Notices:
This document is for informational purposes only and does not constitute a general solicitation, offer or invitation in any Northleaf-managed product in the United States or in any other jurisdiction and has not been prepared in connection with any such offer. The views and opinions expressed herein do not constitute investment or any other advice, are subject to change, and may not be validated by actual events. There can be no assurance that any of the trends highlighted above will continue in the future, Certain of the information set forth herein was gathered from various third-party sources which Northleaf believes to be accurate, but has not been able to independently verify.
This document has been prepared solely for information purposes by Northleaf, and by accessing it, you hereby agree that it is being made available on the express understanding that it will not be reproduced by you to third parties without Northleaf’s prior written consent.
Northleaf Capital Partners® and Northleaf ® are registered trademarks of Northleaf Capital Partners Ltd. All rights reserved.