Bolstered by the strong tailwinds of last year's market conditions, credit fundamentals started 2025 from a position of strength--but soon ran into resurgent headwinds that are sure to shape the second half of this year.

The first quarter saw renewed power across broad credit metric trends as key indicators like revenue, EBITDA, and leverage rose en masse--supported by active issuance in the middle market collateralized loan obligation (MM CLO) market and continually growing demand for private credit. Both selective and conventional defaults as a percentage of total trended lower among credit estimates, while broadly syndicated loans (BSL) also benefited from favorable primary market conditions in the first quarter.

After an extended winter of exits, global investors were starting to lift their expectations for a rebound in mergers and acquisitions (M&A). Sentiment and expectations for how markets would perform for the rest of the year were bullish and strengthening. But market volatility spurred by the U.S. administration's unprecedented tariff announcements since early April has disrupted positive forecasts and prompted a period of prolonged uncertainty.

The primary impact of tariffs on the credit estimated companies in S&P Global Ratings' middle-market CLO universe has thus far been limited, given the portfolio's concentration in service-oriented sectors including software, health care, and professional services. But second-order effects could weigh more heavily on middle-market borrower performance moving forward.

Broader economic trends will influence not only growth and consumption, but also cost of funding for the middle market, where loans are predominantly secured floating-rate instruments tied to benchmark rates set by the Federal Reserve. We expect tariff-driven price increases will lift core inflation, and this may result in fewer interest rate cuts this year than investors had expected. Borrowers whose cash flows are already strained by elevated interest charges would experience exacerbated difficulties.

Global markets have built-in mechanisms to adapt, adjust, and optimize for disruptions and unforeseen events. But the number of unknown unknowns has also risen exponentially in this new environment. Certain trends shape the MM CLO market--credit estimate issuance volumes and key revenue, EBITDA, and leverage metrics, for example--and can help us identify how well-positioned market participants may be in navigating the uncertainty ahead.

(See S&P Global Ratings' Private Credit And Middle-Market CLO Quarterly chartbook for comprehensive data on the credit fundamentals that underpin ratings performance.) In this complementary commentary, we delve deeper into the fundamentals of and thematic trends shaping the MM CLO market—examining credit estimate issuance volumes and key revenue, EBITDA, and leverage metrics—to identify how well-positioned market participants may be in navigating the uncertainty that is clear to continue ahead.

Credit Estimates: Smaller Companies Remain Majority, But Larger Firms Are Multiplying Quickly

In S&P Global Ratings' credit estimate universe, companies grew substantially larger over the past five years. In 2021, over 60% of credit estimates were of borrowers with less than $30 million of EBITDA. By first-quarter 2025, this declined to 50%. Meanwhile, the percentage of companies with more than $100 million of EBITDA reviewed in a single year has more than doubled since 2021.

Nevertheless, the median EBITDA for all credit-estimated borrowers reviewed in this first quarter remained $30 million, and median-adjusted debt was around $200 million, with the majority holding a 'b-' score.

The direct lending market is taking on substantial deals that were previously in the exclusive purview of the BSL market. This reflects the ongoing consolidation and maturation of the private credit industry, and the ability for lenders to fund larger transactions through club deals. Growing concentration among some of the largest private credit lenders affords the largest players greater scale to compete with the BSL market.

Chart 1

Key Revenue, EBITDA, And Leverage Trends: Resurgent And Broad Gains As M&A Recovers

Broad credit metric trends saw upward momentum as key indicators for revenue, EBITDA, and leverage increased across the board. For over 1,400 companies we reviewed, revenue and EBITDA respectively increased in 70% and 64% of cases year over year. Leverage rose in 53% of credit-estimated obligors as companies continued to raise incremental debt to fund add-on and tuck-in acquisitions. Median revenue and EBITDA increased by 15% and 29% respectively, while median leverage rose 27%.

M&A had picked up among credit-estimated borrowers, and it appeared to be on track for an upturn in 2025 until the recent tariff announcements. The pickup was particularly notable among companies with undrawn revolvers or using delayed draw term loans to complete add-on and tuck-in acquisitions despite market volatility.

EBITDA And Cash Interest Coverage Strengthen Amid Rate Cuts

Cash interest coverage ratios had been drifting lower in recent years, tracing the Federal Reserve's rate hikes from March 2022. In 2024, that trend reversed with a modest uptick that continued into the first quarter of 2025. The long-awaited cut in interest rates likely helped to lift cash flows, as many credit-estimated companies were able to reprice at lower spreads amid increased competition with the BSL market.

Chart 2

As of first-quarter 2025, 10% and 33% of companies we reviewed had cash interest coverage ratios of less than 1.0x and 1.5x, respectively (compared with 19% and 48% in 2023). Additionally, 43% and 68% of companies we reviewed also as of the first quarter this year had a free operating cash flow and cash interest coverage ratio less than 1.0x and 1.5x, respectively.

Strengthening cash interest coverage ratio trends are unlikely to persist if credit-estimated companies come under pressure from broader negative macroeconomic conditions and face challenges weathering increased market turbulence.

Ratings Performance: Resilience As Downgrades Decline

In the first quarter of 2025, S&P Global Ratings saw 59 credit estimate downgrades (marking the lowest number of downgrades since the second quarter of 2023) and 55 upgrades. This culminated in a downgrade-to-upgrade ratio of 1.07, up slightly from 1.04 in the previous quarter. For the companies we reviewed in first-quarter 2025, 83% were affirmed, 9% were downgraded, and 8% were upgraded.

This mirrored broad trends in overall ratings of the speculative-grade market, where upgrades rose 28% while downgrades fell 18% on the year. Although down from the previous quarter, positive outlook and CreditWatch revisions continued to exceed negative ones. While first-order impact of the recent tariff announcements will remain limited (given the portfolio's concentration in service-oriented sectors like software, health care and professional services), the net positive outlook for future rating activity may not hold.

Chart 3

Second-order effects could pose challenges in coming quarters with weaker consumer spending, lower corporate investments, recessionary headwinds, and broader market volatility weighing on borrower performance. We expect downgrades to rise gradually over the course of the year ahead given the uncertainty of tariffs and corresponding potential implications for middle-market companies.

This could dovetail with an expected uptick in selective defaults as slowing M&A and leveraged buyout (LBO) transactions limit opportunities for sponsors to exit. If rates and spreads stay elevated, issuers could be forced to seek relief in the form of payment-in-kind (PIK) terms or maturity extensions for loans coming due. Traditional defaults may also be elevated if stressed pockets of issuers have less runway for further support and relief, given more challenging macroeconomic conditions.

Declines in credit quality did not appear to be linked to the size of the borrower. The average or median debt size of the credit estimates that were either downgraded or defaulted appeared to be largely in line with the overall population of credit estimates.

By contrast, the downgraded and defaulted credit-estimated borrowers showed notably lower average EBITDA than credit estimates broadly. For many that were downgraded or defaulted, operational challenges and issues contributed to EBITDA declines over the past year.

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In the first quarter of 2025, both selective and conventional defaults as a percentage of total credit-estimated issuers trended lower. Favorable market conditions fueled more sponsor exits and improved repricing terms, which meant fewer companies exercised PIK options. But financing conditions are likely to be more challenging for issuers to navigate throughout the second quarter, evidenced by pronounced market volatility and uncertainty slowing primary market activity in April alongside widening credit spreads.

While selective defaults have fallen, traditional defaults have ticked up as weaker issuers had less runway given a slower decline in benchmark rates and high funding costs. We expect defaults to remain elevated through this uncertain environment.

Among BSL issuers, the LSTA Leveraged Loan Index default trended downwards toward 1.23% on an issuer count basis. The dual-track loan default rate (when including out-of-court liability management transactions and payment defaults) was higher, at 4.31%, and slightly above our aggregate defaults/selective defaults of 3.90%. The most common reasons for selective defaults in the last 12 months were PIK (71%), followed by amendment to existing term loan transactions (33%), with the remaining (12%) doing both.

Issuance: Volumes Kept Rising, Supported By Demand In Private Credit

The first quarter of 2025 saw roughly 850 new credit estimates assigned. The ratio of new credit estimates to existing credit estimates was broadly unchanged on the year, at 1:3. In our view, active issuance in MM CLO market and rising demand for private credit vehicles supported the continued uptick in credit estimate activity.

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Many middle-market CLO managers we rate have business development companies (BDCs) that use CLOs to fund their direct lending portfolios. Additionally, managers also manage other funds, which they leverage using CLO funding, and there is overlap between the loans held in the middle-market CLOs, and BDCs and other funds.

The buoyant growth of the direct lending portion of the private credit market is partially attributed to the increase in credit-estimated companies, but also due to a significant increase in the size of these companies.

We estimate the aggregate value of committed senior first-lien debt and unitranche loans (including delayed-draw term loans and incremental loans) from companies we've credit estimated over the past 12 months ending March 2025 to be more than $850 billion, versus $750 billion in the same period 2024.

Loan Documents: Maintenance Covenants Have Deteriorated

Maintenance covenants remain the standard in most private credit agreements. However, in many cases, their effectiveness has deteriorated due to increasingly generous leverage limits that make it harder for lenders to act on early signs of borrower underperformance.

More than a third of credit-estimated borrowers subject to actively tested leverage-based maintenance covenants appear to have loose thresholds with current headroom above 40% and even higher proportions in the core and upper segments of the middle market. We believe in the majority of cases, these large cushions reflect covenants that were set very wide to closing levels, as opposed to signaling meaningful deleveraging.

Relatively few borrowers are required to comply with multiple maintenance covenants, which are more common in the lower-middle market and rare in deals with extensive leverage ratio headroom.

Abundant covenant headroom provides flexibility for borrowers in times of stress, but the saturation of covenant-wide terms could ultimately impair recovery values for lenders, like the effect of covenant-lite structuring on defaulted syndicated loans.

For instance, of 22 entities that moved from BSL to private credit last year, eight out of 17 issuers that had covenant-lite structures in the BSL market required a financial maintenance covenant when moving to the private credit market.

Of the 22 BSL agreements, eight did not cap anticipated cost savings/synergy that could be added back to agreement-defined EBITDA. When the entities transitioned to private credit, synergy and cost saving was capped in all but one case (where the deal dispensed with the EBITDA-based covenant and switched to a liquidity covenant). However, one deal that did have a cap for cost saving in BSL removed it when moving to private credit. 

The transfer of core assets from loan collateral packages without lender consent--most notably by J.Crew Group Inc. In 2016--sparked significant concern among leveraged loan market participants about the loosening of protections. Since then, loan investors have increasingly added protective language to loan documents in an attempt to reduce the risk of IP transfers outside of the collateral package. These provisions are sometimes referred to as "J.Crew Blockers."

Six issuers did a deal in the BSL market much after the J. Crew transaction and still did not include a J. Crew Blocker.  When they were refinanced in the private credit market, five of them added a blocker, and the sixth one removed the concept of unrestricted subsidiaries altogether. 

The growth of private credit is helping fund the rise of out-of-court restructurings amid challenging credit conditions for many highly-levered companies as private lenders can often be more creative than institutional debt markets in crafting terms to benefit new loans while ensuring the company (and their sponsors) get the liquidity and flexibility they need to reduce the risk of an imminent default or bankruptcy.

Looking Ahead: Second-Quarter 2025 Outlook Turns Negative As Indirect Impact Of Tariffs Play Out

Global capital markets are experiencing a seismic shift as geopolitical and trade relationships evolve. The second quarter of 2025 ushered in a bout of volatility and the steepest decline in the equity markets since 2020, swiftly followed by a significant widening of credit spreads.

While the full impact of tariffs on global markets is yet to be seen, the repercussions upon the middle market may be tempered--as many of the obligors in CLO collateral pools are isolated in less-effected sectors (mainly software and health care) that are not directly disrupted in global supply chains (as the automotive or metals and mining sectors are).

We expect the first indicator of stress to surface in selective defaults. While first-quarter 2025 figures have shown improving conditions, we believe this is unlikely to endure. 

Related Research

• Private Credit And Middle-Market CLO Quarterly: Unknown Unknowns, April 25, 2025
• U.S. Leveraged Finance Q1 2025 Update: Private Credit Boom Narrows Gap To BSL Market, April 24, 2025
• Loose Maintenance Covenants Permeate Private Credit, Report Says, April 23, 2025
• Documentation, Flexible Structuring Continue To Reign In Private Credit, Sept. 17, 2024
• How Aggressive Out-Of-Court Loan Restructurings Threaten Institutional First-Lien Recovery Prospects, July 3, 2024