Probability of Default (PD)
Private Credit glossary · Underwriting & Credit Analysis
Definition
Expected likelihood that a borrower will default within a specified horizon (typically 1 year). In the Merton structural model, the risk-neutral PD has a closed form: PD = N(-d_2) where d_2 = [ln(V/D) + (r - σ^2/2)T]/(σ√(T)). For US middle-market direct loans the historical realized PD is roughly 2%–3% annually for senior secured and 4%–6% for second-lien/mezzanine.
Probability of Default (PD) in plain English
Probability of default, or PD, is simply the estimated chance that a borrower fails to pay back a loan as promised within a set window — usually the next year. It's the number lenders lean on most, because a loan paying nice interest is worthless if the borrower won't repay; PD is the honest odds of that going wrong. In real life, loans to mid-sized US companies default roughly 2%–3% a year when the lender is first in line to be repaid (senior secured), and a riskier 4%–6% when the lender sits further back in line (second-lien or mezzanine). There's even a famous formula (the Merton model) that estimates PD from how much a company owes versus what it's worth and how wildly its value swings — the shakier and more indebted the borrower, the higher the PD.
Also called: PD
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