In this lesson
- Terms: Default and recovery, Distressed debt, Senior and subordinated debt, Covenant
- To work through: a worked example, a 32-second film, 3 check questions
Underlined terms show their definition when you rest on them or tap them.
A default happens when a borrower misses a payment or breaks the loan’s terms. What the lender then recovers, through a sale, a restructuring or a bankruptcy, is the recovery rate. The loss on a loan book over a year is roughly the share of loans that default times the share of each one that is lost.
The Fed note found default rates in 2023, to October, were generally low compared with the syndicated loan market, particularly in direct lending. It also warned that the industry has not been through a prolonged recession at its current size.
Recoveries are the other half. Citing data from KBRA DLD, the Fed note put the post-default value of a direct loan at around 33%, against 52% for syndicated loans and 39% for high-yield bonds. A low default rate with a low recovery can produce the same loss as a higher default rate with a better one.
Timing matters too. The Fed note found about 16% of private credit outstanding was due in 2024, with the rest spread fairly evenly; loans that cannot be refinanced when they fall due are where defaults show up.
Two loan books. Loss a year ≈ default rate × (1 − recovery rate).
| Book A: 2% defaults, 33% recovered | about 1.34% lost a year |
|---|---|
| Book B: 3% defaults, 52% recovered | about 1.44% lost a year |
| Book A earns a spread of 5.5% | about 4.2% left after losses |
Fewer defaults did not mean much smaller losses once recoveries were counted. Simple example: ignores fees, timing and costs.
Key takeaway: why it matters to investors
A credit fund’s return is its interest minus its losses, and losses depend on recoveries as much as on defaults. Reading a low default rate without the recovery rate, or a short track record as if it covered a full cycle, overstates what an investor keeps.
Watch · 32 seconds
A default isn't the loss. What comes back is.A default is a borrower's failure to meet a loan's terms, such as missing a payment or breaking a covenant. Recovery is the share of what is owed that the lender gets back afterward.
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Sources
The facts in this lesson were checked against these public pages on November 11, 2026. Examples use round invented numbers. Simple examples; terms vary by fund.
- Private Credit: Characteristics and Risks (FEDS Notes, February 23, 2024; Fang Cai and Sharjil Haque), Board of Governors of the Federal Reserve System. Definition (debt-like, non-public instruments from non-bank lenders, mostly through funds and BDCs); nearly $1.7 trillion as of June 2023, direct lending about $800 billion or half; borrowers typically middle-market firms with $10 million to $1 billion of revenue; direct loans typically senior secured; about 15% hybrid loans, more junior; almost all floating rate; average maturity around five years, about 16% due in 2024; spreads above syndicated term loans; mean interest coverage about 2.0x vs 2.7x for leveraged loans (2023); default rates low vs syndicated loans through October 2023, not yet tested by a prolonged recession; post-default value around 33% vs 52% syndicated loans and 39% high-yield bonds (KBRA DLD); recent deals often without financial maintenance covenants (industry commentary); Form PF Q4 2021: pensions about 31% of private credit fund assets, other private funds 14%, insurers and individuals about 9% each; BDCs created by the Small Business Investment Incentive Act of 1980.
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