Defaults: Systemic or idiosyncratic?

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Written By Cliffwater
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Cliffwater

Cliffwater LLC (“Cliffwater” or “the Firm”) is an independent alternative investment adviser and fund manager. Founded in 2004, Cliffwater has been shaping how alternatives are understood and accessed through its research, proprietary indices, and innovative evergreen private markets funds. The Firm’s research has been cited in industry-leading publications and led to the creation of the Cliffwater Direct Lending Index (“CDLI”), the first published index and widely accepted benchmark for direct lending, and its suite of sub-indices. Cliffwater is also one of the largest providers of alternative investment solutions for the wealth management channel. The Firm’s private markets interval fund platform is now the largest in the market with $44 billion in net assets as of October 31, 2025, and includes the two largest credit interval funds.

Markets

19 February 2026

9 minutes reading time

  • Private assets
  • Private credit

This article was written by Stephen Nesbitt, Cliffwater CEO and has been republished with Cliffwater’s permission. Cliffwater are the inaugural partners of Betashares Private Capital and manage the underlying fund into which the Betashares Private Capital | Cliffwater Private Credit Fund invests. Betashares has not verified and does not warrant the accuracy or completeness of the information, and the article does not necessarily represent the views or opinions of Betashares.

Recently, we also launched our new Betashares Private Capital newsletter. You can sign up for it at https://subscriptions.betashares.com.au/.

The investment press sees systemic risk in every default while lenders argue idiosyncratic circumstances. Who is right? Our research shows that the press commonly mistakes one-off defaults as something greater than what they are. A range of risks underlie defaults, which are catalogued below, but we believe the presence of systemic risk is generally exaggerated and, unfortunately, never predictable. Like much else in private debt, this means diversification and loan protection are top priorities across the market cycle.

High realised losses (aka write-offs) reported by the Cliffwater Direct Lending Index (CDLI) would be the best indication, in our view, that systemic risk is unfolding in the credit markets. That is not happening. Realised losses through September 2025 have been averaging an annualised 0.68% in recent years, well below the historical 1.00% realised loss rate. Even when recent vintage loans are excluded from CDLI, realised losses have been averaging at or below historical averages.

High unrealised losses (aka write-downs) reported by the CDLI would be the best indication from our research whether systemic risk is expected to unfold in the credit markets. That also is not happening. Unrealised losses have effectively been zero in recent years, even when recent loan vintages are excluded from the calculation.

The recent absence of unrealised market-wide losses (write-downs) is not a sign of poor valuation procedures. We have shown that CDLI unrealised losses have tended to reliably precede but overstate subsequent realised losses (defaults). Collectively, those overseeing loan valuations are doing their job.

Private debt investors get rewarded to absorb bad news, which comes from many sources. With roughly 10,000 unique middle market borrowers reflected in CDLI, 200 default-related news stories could be written each year.1 Most defaults reflect borrower idiosyncratic risk, unique to individual borrower circumstances. Industry risk ranks second in importance. In the last 10 years alone, energy, consumer, healthcare, and now software have temporarily elevated default levels. Manager risk ranks third, capturing the quality of underwriting on the part of lenders. Apollo, Blackstone, Monroe, Oaktree, Goldman, and others have endured short-term periods of above-average default losses, in part, due to poor underwriting. For a few other lenders, high default rates are persistent. Finally, there is recession risk, which is systemic across risky credits, public or private, and unforecastable. These four sources of risk can be amplified through financial risk when leverage or structuring are present.

What about falling prices for exchange-traded business development companies (BDCs)? Is that a potential canary? Our research shows that BDC pricing, represented by the Cliffwater BDC Index (www.bdcs.com), is a poor predictor of systemic risk ahead. For example, in 2011, public BDC prices dropped 30%, but subsequent CDLI values remained largely unchanged. However, BDC pricing is generally good at identifying manager and other risks, as the recently reported BlackRock write-downs demonstrated. BlackRock (formerly known as Tennenbaum) historically priced above net asset value, reflecting strong performance and a reliable investment team. After the BlackRock purchase, management changed, performance suffered, and the BDC began to consistently trade below net asset value, reaching a whopping 38% discount at year-end. The public BDC market clearly foreshadowed the subsequently announced write-downs (unrealised losses).

Financial risk, through subordinated debt and equity structuring, worsened BlackRock’s BDC losses. The exhibit below is one we regularly produce that shows how additional volatility is introduced when relatively-low volatility senior lending is replaced by higher-volatility subordinated (second lien) and other (equity-linked) lending. Compounding structuring risk, the BlackRock BDC deployed 50% more portfolio-level leverage than the average BDC, causing perhaps manageable problems to approach unsustainable levels. 

Exhibit 1: Historical Price Volatility by Loan Seniority, September 2004 to September 2025

Past performance is not an indicator of future performance.

Private debt has the potential to deliver attractive and consistent returns when enhanced diversification, loan protection, cash yield, reasonable fees and prudent leverage levels are in place.

Footnote:

1: Assuming historical 2% annual default rate for CDLI. 

Important Disclosure Information The views expressed herein are the view of Cliffwater LLC (“Cliffwater”) only through the date of this report and are subject to change based on market or other conditions. All information has been obtained from sources believed to be reliable but its accuracy is not guaranteed. Cliffwater has not conducted an independent verification of the information. The information herein may include inaccuracies or typographical errors. Due to various factors, including the inherent possibility of human or mechanical error, the accuracy, completeness, timeliness and correct sequencing of such information and the results obtained from its use are not guaranteed by Cliffwater. No representation, warranty, or undertaking, express or implied, is given as to the accuracy or completeness of the information or opinions contained in this article. This article is not an advertisement, is being distributed for informational and discussion purposes only, should not be considered investment advice, and should not be construed as an offer or solicitation of an offer for the purchase or sale of any security. The information herein does not take into account any investor’s particular investment objectives, strategies, tax status or investment horizon. Cliffwater shall not be responsible for investment decisions, damages, or other losses resulting from the use of the information. This report is not intended for public use or distribution. The information contained herein is confidential commercial or financial information, the disclosure of which would cause substantial competitive harm to you, Cliffwater, or the person or entity from whom the information was obtained, and may not be disclosed except as required by applicable law. The information in this article is not intended as a recommendation to invest in any particular asset class or strategy or as a promise of future performance. Note that these asset class and strategy assumptions are passive only, and they do not consider the impact of active management. References to future returns are not promises or even estimates of actual returns a client portfolio may achieve. Statements that are nonfactual in nature, including opinions, projections and estimates, assume certain economic conditions and industry developments and constitute only current opinions that are subject to change without notice. Further, all information, including opinions and facts expressed herein are current as of the date appearing in this article and is subject to change without notice. Unless otherwise indicated, dates indicated by the name of a month and a year are end of month. There can be no assurance that any expected rates of return or risk will be achieved. 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Nothing contained in this article is, or shall be relied upon as, a representation as to past or future performance, and no assurance, promise, or representation can be made as to actual returns. Past performance is not indicative of future returns, which may vary. Future returns are not guaranteed, and a loss of principal may occur. The Cliffwater Direct Lending Index (the “CDLI”) seeks to measure the unlevered, gross of fees performance of U.S. middle market corporate loans, as represented by the underlying assets of Business Development Companies (“BDCs”), including both exchange-traded and unlisted BDCs, subject to certain eligibility requirements. The CDLI is an asset-weighted index that is calculated on a quarterly basis using financial statements and other information contained in the U.S. Securities and Exchange Commission (“SEC”) filings of all eligible BDCs. The CDLI will be reconstituted typically within 75 calendar days, but no later than 90 calendar days, following the current Valuation Date. The precise date of reconstitution is within Cliffwater’s discretion. If a BDC meets the eligibility criteria, but has not filed its report on Form 10-K or 10-Q with the SEC at the time the index is reconstituted, asset information from its report will be included in the index at the time of the next reconstitution. The eligibility criteria for inclusion in the CDLI is – all assets held by BDCs that meet the following criteria: (1) Regulated by the SEC as a BDC under the Investment Company Act of 1940, (2) substantial majority (approximately 75%) of reported total assets are represented by direct loans made to corporate borrowers, as categorized by each BDC and subject to Cliffwater’s discretion and (3) File SEC form 10-Q (or 10-K, as applicable) within 75 (or 90) calendar days following the current Valuation Date. Cliffwater believes that the CDLI is representative of the direct lending asset class. The CDLI is owned exclusively by Cliffwater and is protected by law including, but not limited to, United States copyright, trade secret, and trademark law, as well as other state, national, and international laws and regulations. Cliffwater provides this information on an “as is” and “as available” basis, without any warranty of any kind, whether express or implied. Past performance of the CDLI is not indicative of future returns. Any CDLI returns or other information shown are not based on actual advisory client returns and do not reflect the actual trading of investible assets. The performance of the CDLI has not been reviewed by an independent accounting firm and has been prepared for informational purposes only and should not be considered investment advice. Index returns do not reflect payment of any sales charges or fees a person may pay to purchase the securities underlying the CDLI or a product that is intended to track the performance of the CDLI. The imposition of these fees and charges would cause the actual performance of these securities or products to be lower than the CDLI. The CDLI data contained herein cannot be reused in whole or in part for any purpose without the expressed written consent of Cliffwater. The CDLI is derived from sources that are considered reliable, but Cliffwater does not guarantee the veracity, currency, completeness or accuracy of the CDLI or other information furnished in connection therewith. The CDLI may include inaccuracies or typographical errors. Due to various factors, including the inherent possibility of human or mechanical error, the accuracy, completeness, timeliness and correct sequencing of such information and the results obtained from its use are not guaranteed by Cliffwater. No representation, warranty or condition, express or implied, statutory or otherwise, as to condition, satisfactory quality, performance, or fitness for purpose are given or duty or liability assumed by Cliffwater in respect of the CDLI or any data included therein, omissions therefrom or the use of the CDLI in connection with any product, and all those representations, warranties and conditions are excluded save to the extent such exclusion is prohibited by applicable law. Cliffwater is a service mark of Cliffwater LLC. 

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Cliffwater
Cliffwater LLC (“Cliffwater” or “the Firm”) is an independent alternative investment adviser and fund manager. Founded in 2004, Cliffwater has been shaping how alternatives are understood and accessed through its research, proprietary indices, and innovative evergreen private markets funds. The Firm’s research has been cited in industry-leading publications and led to the creation of the Cliffwater Direct Lending Index (“CDLI”), the first published index and widely accepted benchmark for direct lending, and its suite of sub-indices. Cliffwater is also one of the largest providers of alternative investment solutions for the wealth management channel. The Firm’s private markets interval fund platform is now the largest in the market with $44 billion in net assets as of October 31, 2025, and includes the two largest credit interval funds. Read more from Cliffwater.
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