Private Credit Market Update: Q2-2026
Q2-2026 Market Update
The second quarter was characterized by continued market volatility driven by inflationary pressures, geopolitical uncertainty and concerns around AI-related disruption. Within private credit, however, borrower performance remained stable, while a pullback in supply contributed to wider credit spreads and improved lender terms. Combined with elevated base rates, these conditions created an attractive environment for investors, supporting strong all-in yields and attractive risk-adjusted returns.
Against this backdrop, the following key trends shaped the private credit market in Q2:
U.S. base rates remained unchanged during the quarter, although the Federal Reserve indicated the possibility of a modest increase later this year amidst persistent inflationary pressures.
Lenders with stable, long-term capital are seeing increasingly attractive opportunities to invest as retail-oriented sources of capital retrench in favour of liquidity management.
Credit spreads continue to widen, reflecting overall volatility in the market and the evolving competitive environment.
Borrower performance has remained broadly resilient, though greater bifurcation has emerged across sectors, vintages and business models more exposed to AI-related disruption.
U.S. base rates remained unchanged during the quarter, although the Federal Reserve indicated the possibility of a modest increase later this year amidst persistent inflationary pressures.
During the quarter, the Fed held its target range for the federal funds rate steady at 3.50% to 3.75%, though the Fed’s projections and the forward curve shifted higher, reflecting a more hawkish path than expected earlier in the year against a backdrop of elevated inflation and a stable labour market. Current market projections indicate an average base rate of ~3.9%1 over the remainder of 2026 to 2028 (see Figure 1), approximately 40 basis points higher than projected last quarter. However, uncertainty persists regarding the trajectory of interest rates, with Fed officials remaining divided on the timing and magnitude of potential rate changes.
Figure 1: Projected U.S. Base Rates
July 2026 to December 2028
Source: Chatham Financial. 3-month SOFR forward curve as of July 2, 2026, and Fed projections as of June 17, 2026. There can be no assurance that any of these projections will be validated by actual events.
Lenders with stable, long-term capital are seeing increasingly attractive opportunities to invest as retail-oriented sources of capital retrench in favour of liquidity management.
Overall, direct lending activity remained relatively soft through the first half of 2026 as private equity sponsors remained selective in pursuing new platform investments amid an uncertain macro backdrop (see Figure 2). In addition to pursuing new platform deals, sponsors appear to be increasingly focused on existing portfolio companies, with add-on acquisitions rising from 20% to 25%2 of deal activity compared to the prior year period. At the same time, elevated U.S. non-traded business development company (“BDC”) redemption activity led some retail-oriented lenders to prioritize liquidity over new originations, creating a shift in market share toward institutionally backed lenders, many of whom benefited from more robust and elevated origination volumes compared to the overall market. This shift in supply dynamics has supported attractive economics and more favorable transaction structures for disciplined and well-capitalized lenders. Looking ahead, sponsor dialogue and deal pipelines strengthened in the quarter, suggesting the potential for a more robust origination environment in the second half of 2026.
Figure 2: Moderation in M&A/LBO Volumes
Source: Pitchbook/LCD. Data through June 30, 2026. U.S. direct lending estimated volumes, LBOs.
Credit spreads continue to widen, reflecting overall volatility in the market and the evolving competitive environment.
Credit spreads in the U.S. have widened relative to the start of the year, reflecting higher market volatility and the evolving competitive environment described above. Through the quarter, new issue pricing for U.S. sponsor-backed middle market transactions widened by approximately 25 basis points. In contrast, credit spreads in Europe remained relatively flat in the first half of the year, which can partly be explained by more stable supply dynamics throughout the quarter compared to North America. With elevated U.S. base rates and widening spreads, gross asset yields continue to remain attractive at high-single digit unlevered yields (see Figure 3).
Figure 3: Private Credit has Historically Provided 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 June 30, 2026. Quarterly figures calculated as a 3-month average. There can be no assurance that the trends highlighted above will continue in the future.
Borrower performance has remained broadly resilient, though greater bifurcation has emerged across sectors, vintages and business models more exposed to AI-related disruption.
While overall borrower fundamentals remain broadly resilient, performance is becoming more bifurcated, with heightened risk continuing across certain segments of the market (particularly consumer-facing industries), vintages (particularly 2021), and business models, with stress concentrated in select borrowers rather than reflecting systemic weakness across the asset class.
KBRA raised its 2026 default forecast for the KBRA DLD Direct Lending Index to 2.5% from 2.0%3, reflecting a modest uptick from historically low levels. Despite this, investors remain well compensated for the level of credit risk in today's market environment based on current gross asset yields and the near-term yield outlook.
While the potential disruption from AI remains a key area of focus, company performance has generally remained resilient, with many businesses currently benefiting from AI-driven productivity gains and cost efficiencies. Consistent with this backdrop, we have not observed AI-related deterioration among borrowers in the private credit market to date. However, given the potential for AI-driven volatility to reshape competitive dynamics over time, particularly within the software sector, market participants have adopted a more selective approach to underwriting new investments.
While volatility remained elevated in the broader market through the quarter, the combination of resilient borrower performance, higher-for-longer base rates and wider credit spreads continued to provide attractive risk-adjusted returns for private credit. However, in an environment with greater performance bifurcation, managers with differentiated sourcing capabilities, disciplined underwriting and active portfolio management are better positioned to deliver consistent returns for investors.
Endnotes:
Unless otherwise indicated, all figures and metrics are in USD and as at June 30, 2026.
“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: Chatham Direct. Represents simple average of 3 month term SOFR forward curve as of July 2, 2026. Data from July 2026 through to December 2028.
Source: KBRA DLD Default Research. Figures reflective of percentage of new volume U.S. sponsored deal activity and compares the YTD period through to June 30, 2025, and YTD period through to June 30, 2026, respectively. There can be no assurance that the trends highlighted above will continue in the future.
Source: KBRA DLD Default Research. Figures as of June 8, 2026, and February 17, 2026, respectively, and reflective of 2026F projected middle market default rate based on total volume of issuance for all direct lending transactions. There can be no assurance that projections will be validated by actual events.
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.
Private Credit at Northleaf
Northleaf invests across corporate direct lending and asset-based specialty finance to provide investors with diversified exposure to mid-market loans globally, offering a range of flexible financing solutions.
