2026 Credit Research Outlook Can we keep muddling without breaking?

Despite late-cycle risks—high rates, inflation, private credit growth—strong bank capitalization, stress testing, and moderate private debt suggest volatility ahead, not systemic collapse.

The backdrop for credit markets in 2026 reflects several characteristics typical of a late-cycle phase. Macroeconomic conditions are adequate, though not exceptional, and financial conditions remain accommodative. While corporate and consumer credit fundamentals are generally robust, elevated valuations across most areas of the credit markets may expose investors to increased volatility. This risk is particularly relevant given late-cycle indicators such as rising M&A activity, leveraged buyouts, higher capital expenditures, shareholder-focused initiatives, and an uptick in corporate bankruptcies.

Indeed, toward the end of 2025, there were several high-profile corporate bankruptcies—such as First Brand (auto parts) and Tricolor (subprime auto lending)—alongside markdowns by regional US banks on their exposure to commercial real estate. We viewed these occurrences as idiosyncratic credit events driven by company-specific factors, such as fraud or vulnerabilities in certain sectors, rather than signs of broader credit market distress. Aggregate credit market fundamentals support this view; however, these events underscore how a prolonged period of elevated inflation and high interest rates has placed pressure on specific segments of the economy.

If anything, these developments highlight the fragility of credit market valuations in the latter part of the cycle, as certain segments repriced in their aftermath.

While First Brands and Tricolor were not financed through private credit markets, the lack of transparency surrounding these bankruptcies drew attention to the opacity of private credit portfolios. Although there is no universally agreed-upon definition of private credit, it is clear that non-bank lending has surged since the global financial crisis (GFC), driven largely by significant regulatory changes affecting banks.

According to Morgan Stanley research,¹ private credit lending in the US grew by approximately 50% between 2020 and 2025, reaching an estimated $3 trillion—an amount that now exceeds the size of both the public US high-yield bond market and the broadly syndicated loan market (Private Credit Outlook: Estimated $5 Trillion Market by 2029 | Morgan Stanley).

Systemic risk considerations in credit markets

Evaluating systemic risk factors remains a critical consideration in today’s credit market landscape, particularly in light of recent corporate credit events. A key concern is whether these developments signal the onset of a broader default cycle that could impact both public and private credit markets. The implications of such a cycle could be far-reaching, influencing credit availability, valuations, and investor confidence across the financial system

Another critical area of focus is the growing interconnectedness between banks and alternative asset managers, particularly private credit lenders. This increased linkage heightens the potential for systemic risk, as shocks in one segment of the market can more easily transmit across the financial system. The evolving relationships between traditional banks and non-bank lenders warrant close analysis, given the rapid growth of private credit and the changing structure of credit markets.

As globally systemic banks represent the most significant component of our Cash investment portfolios, we maintain a strong emphasis on monitoring developments within this sector. We continue to allocate resources to analyzing the nature and extent of the interconnectedness between banks and alternative asset managers. This ongoing assessment is essential for identifying potential vulnerabilities and ensuring robust risk management for our funds in the current late-cycle environment.

Banks within our investment universe view private credit as an increasingly important component of their lending ecosystem. The most direct source of interconnectedness with alternative asset managers operating in the private credit space is reflected in banks’ loans to non-depository financial institutions (NDFIs).

According to the FDIC,² US bank loans to NDFIs now account for approximately 10% of total bank lending, exceeding $1.1 trillion—up from 6% in 2021. These figures exclude unfunded lending commitments, which are estimated to add another $1 trillion in potential exposure (Banking Analytics: The Growing Connection between Bank and Nonbank Sectors).

Since 2010, NDFI lending has grown at a compound annual growth rate (CAGR) of 23%, including a 15% CAGR from 2015 to 2023—nearly double the pace of the next fastest-growing sector, multifamily lending, which posted an 8% CAGR. This sharp acceleration underscores the need for heightened scrutiny of NDFI exposures, particularly as they become an increasingly prominent component of bank balance sheets.

This development has been largely driven by post-GFC regulatory reforms, which prompted banks to scale back direct lending in certain corporate sectors and de-risk their balance sheets. In response, NDFI lenders stepped in to fill the gap, offering borrowers faster and more predictable loan execution. However, if banks are now lending to NDFIs, have they truly de-risked their balance sheets? We believe they have—at least to some degree.

Lending to NDFIs

Banks on our credit approval list emphasize that their NDFI exposures are well-secured with collateral, highly diversified, and governed by structured risk controls. When making direct corporate or business loans, any default exposes the bank to a credit loss. In contrast, non-recourse loans to NDFI lenders are not exposed to individual borrower defaults within the NDFI portfolio. These loans are secured with collateral and structured so that the bank only incurs losses above the attachment point of the structure, which typically covers a diverse pool of underlying loans originated by the NDFI. Consequently, the risk banks assume with this type of lending is mitigated by conservative loan-to-value ratios, broad diversification across businesses and sectors, shorter loan durations, and risk-based pricing. For banks on our approval list, loss content in NDFI lending has historically been much lower—both in frequency and severity—than in direct corporate or consumer lending portfolios.

Private credit markets are materially larger in the US compared to other jurisdictions within our investment universe. As a result, disclosures related to private credit and bank lending to NDFIs are less informative outside the US banking system, partly due to lower aggregate materiality within those systems. Nevertheless, we have been analyzing available financial statements and industry sources to frame and quantify relevant risk parameters. This exercise is particularly important for our coverage of European banks, given the growth trajectory of NDFI exposure. According to a 2024 European Banking Authority report, EU banks’ exposures to NDFIs “amounted to 9.2% of consolidated bank assets” (J.P. Morgan European Credit Research; 2026 European Financials Outlook; 11/12/25). We have confirmed that most European banks in our coverage universe have exposures broadly consistent with this report. Similar to our US bank investment counterparties, while we expect some headline volatility related to these exposures, we do not anticipate material credit profile impacts in the context of current earnings.

One area we continue to monitor regarding NDFIs and European banks is the liability side of the balance sheet. European banks commonly use Significant Risk Transfer (SRT) debt—also known as credit risk transfer—to enhance capital efficiency, preserve lending relationships, and transfer credit risk to third-party investors. SRT allows banks to retain underlying loans on their books—maintaining customer relationships—while offloading a portion of risk exposure, enabling continued lending without diluting regulatory capital. However, according to a recent EBA report, private credit investors (NDFIs) comprise roughly one-third of the current SRT investor base (J.P. Morgan European Credit Research; 2026 European Financials Outlook; 11/12/25). If this significant portion of the investor base were to retrench from the SRT market, some of the risk that private credit players have disintermediated away from banks could indirectly return to bank balance sheets in the form of refinancing risk—over and above any existing direct exposure through banks’ lending to these entities. The EBA report notes that there is no steep “maturity wall” in the refinancing profile of SRTs at either the system or individual bank level, but we continue to monitor this situation closely given the absence of a liquid secondary market for SRTs.

Private credit portfolios and the NDFIs that originate them are not immune to losses, particularly in the event of a recession. However, for the reasons outlined above, we believe the risk of systemic banking stress from deterioration in NDFI credit performance remains low at present. Still, rapid growth in any asset class warrants vigilance. While greater transparency should help ease lingering concerns, recent events remind us that banks are confidence-sensitive. Even occurrences that are manageable from a loss-absorbing perspective—such as those covered by capital, reserves, and core earnings—or that are idiosyncratic in nature, as exemplified by recent instances of fraud, may nonetheless undermine market sentiment.

Other sources of credit market fragility that we are monitoring include:

• Macroeconomic risks: FOMC members currently foresee upside risks to both unemployment and inflation, raising concerns about stagflation. Such conditions would further stress already vulnerable segments of the credit markets—namely high-yield and leveraged loan corporates (including private markets), certain areas of commercial real estate (CRE), and subprime consumer lending.
• Valuation risk in investment grade credit: Credit spreads in investment-grade (IG) markets are at or near historical tights across most segments. Moreover, there is little dispersion within IG credit, leaving spreads and valuations particularly susceptible to a material repricing if macroeconomic conditions underperform expectations. Such a repricing could lead to a broad tightening of overall credit conditions.
• Structural liquidity concerns: While this is likely a longer-term issue, continued growth in the private credit market may constrain central banks’ ability to achieve policy objectives and maintain market stability. As private lenders’ share of the market increases, overall system liquidity declines, reducing the amount of money central banks can inject into the banking system during periods of stress. Banks can borrow from central banks in times of stress by pledging assets; private credit firms cannot. This structural limitation could amplify liquidity challenges in a downturn.

Stable outlook for cash credit investing

Despite the risks outlined above, several mitigating factors suggest that any upcoming downturn in this credit cycle is unlikely to be as severe as those in recent history. Private sector debt growth does not appear to mirror past episodes of credit excess, which bodes well for peak-cycle credit loss rates. Since 2008, the US private sector—including households, financials, and non-financial businesses—has steadily de-levered, with private sector credit-to-GDP at 208% versus 293% pre-GFC. Much of the increase in aggregate debt-to-GDP over the past 15 years has come from the public sector, while household debt-to-GDP has fallen to 20-year lows. Even within private credit, there are few signs of excess: lending from non-banks (including NDFIs) grew from about 20% to 26% of GDP at its peak but has been declining in recent years relative to GDP, mirroring the trend in total lending³ (banks + non-banks).

Importantly, for our major Cash investment counterparties, there is a strong basis for stability in 2026. As we have reiterated over the past few years, the regulated global banking system today is better capitalized and less leveraged than before previous crises. While asset quality has received heightened attention across the banking sectors we cover, nonperforming assets, net charge-offs, and allowance for credit losses have remained largely unchanged over recent quarters and are strong by historical standards. Major consumer asset classes such as mortgages and credit cards have shown improved year-over-year performance for many banks on our approval list. Although a handful of corporate credit events have attracted outsized attention, the overall backdrop appears stable—though we acknowledge that credit quality is inherently cyclical. In our view, a sharper economic slowdown, a significant rise in unemployment, or a macroeconomic shock would be required to materially alter this trajectory.

Another defining feature of the current credit cycle has been the positive impact of the interest rate environment and yield curve on bank profitability. European banks, in particular, have been major beneficiaries within our investment universe, as their structural profit trajectory has materially improved. This provides an additional buffer to absorb any downturn in the credit cycle, should it occur. European banks enter 2026 in a stable position, supported by return-on-equity and capitalization levels near record highs, while credit costs remain close to historical lows.

Europe’s persistent high-deficit countries (France, Belgium, UK) are likely to remain a recurring source of volatility, as they have in recent years. While French politics poses a risk for 2026, we believe there is limited direct contagion from domestic sovereign exposures of French banks. In our view, the banking sector is well-positioned to weather these challenges.

In closing

Although credit market risks have persisted for several years, recent idiosyncratic events underscore how prolonged credit cycles are particularly vulnerable to high interest rates and persistent inflation. Near-term challenges are more likely to generate intermittent volatility rather than trigger systemic risk. We continue to favor larger, systemically important banks with scale and strong risk management histories as investment counterparties.

While not a “cure-all” for risk, formal annualized stress tests conducted by credible regulators (Fed/CCAR, ECB, BoE) have proven valuable in identifying key sources of systemic risk since the GFC. Banks on our credit approval list continue to participate in these exercises, mitigating some of the risks that could otherwise degrade credit profiles. Even regarding the explosive growth of private credit, these exercises have helped quantify risks associated with banks’ lending to NDFIs, reinforcing our conviction in focusing on large, systemically important banks as counterparties.

In a digital banking world, episodes of confidence-driven “doom loops,” as seen in 2023, serve as cautionary tales: isolated incidents perceived as widespread (“cockroach effect”) can drive stakeholders to seek higher ground, amplifying volatility. Our investment counterparties are better prepared and equipped to perform strongly amid such volatility. For example, JPMorgan’s $170M loss on NDFI exposures in 3Q25 (related to the First Brands bankruptcy) represented only 0.8% of its quarterly profit. By contrast, regional banks (not on our credit approval list) reported similar nominal losses that equated to ~20% of quarterly earnings. We continue to select cash investment counterparties best positioned to maintain their fundamental credit profiles across a range of macroeconomic scenarios.