The final week of 2025 concludes a transformative year for middle market finance, defined by the paradox of record-breaking private credit growth alongside emerging structural vulnerabilities that tested the industry’s underwriting discipline. While the holiday week remained characteristically quiet, 2025 was anything but, as the Federal Reserve’s belated pivot to accommodation intersected with high-profile credit events — most notably the First Brands fraud scandal and the Blue Owl fund merger controversy — that exposed fundamental questions about collateral verification, valuation transparency, and liquidity provisions in privately held credit structures.
For middle market lenders, borrowers, and their advisors, 2025 delivered a year of reckoning. The private credit market surged past $3.5 trillion in global assets under management, yet the sector simultaneously faced its most significant tests since the pandemic-era dislocations. Asset-based lending emerged as a bright spot amid the turbulence, while traditional direct lending confronted spread compression, heightened competition from the broadly syndicated loan market, and mounting concerns about portfolio quality in a borrower-friendly environment.
The Federal Reserve’s Fractured Pivot
The defining macroeconomic narrative of 2025 was the Federal Reserve’s halting transition from restrictive policy to measured accommodation—a pivot marked by unprecedented internal divisions that may reshape monetary policy governance heading into 2026. After maintaining elevated rates through much of the year as the Committee assessed tariff-driven inflation risks, the FOMC delivered three consecutive cuts in the final quarter, bringing the federal funds rate to a range of 3.50%-3.75% by year-end—the lowest level since 2022.[1]
The December 10 decision proved particularly contentious, with the Committee splitting 9-3 on the quarter-point reduction. Governor Stephen Miran dissented in favor of a larger 50-basis-point cut, while Chicago Fed President Austan Goolsbee and Kansas City Fed President Jeffrey Schmid argued for holding rates steady—a configuration of opposing dissents not seen since September 2019.[2] The internal discord extended beyond voting members, with four additional non-voting participants registering ‘soft dissents’ in the updated dot plot, reflecting fundamental disagreements about whether inflation persistence or labor market deterioration poses the greater risk to the Fed’s dual mandate.
Chair Jerome Powell characterized the current policy stance as ‘well positioned to wait and see how the economy evolves,’ with the federal funds rate now residing in the ‘high end of the range of neutral.’ The Fed’s economic projections maintained only 25 basis points of additional cuts for 2026, a notably hawkish stance that contrasts with market expectations for more aggressive accommodation. The divisions that defined 2025 are expected to persist, particularly as a new Fed Chair nomination looms in early 2026 following the conclusion of Powell’s term in May.[3]
For middle market borrowers, the year’s rate trajectory provided meaningful but incomplete relief. The cumulative 175 basis points of easing since September 2024 translated to reduced interest expense for floating-rate facilities, yet all-in borrowing costs remained substantially elevated relative to pre-2022 levels. With SOFR-based pricing still commanding spreads of 500-600 basis points over the benchmark, interest coverage ratios across middle market portfolios continued to face pressure despite the Fed’s accommodation.
Private Credit: Growth Meets Gravity
Private credit’s expansion continued at a remarkable pace in 2025, with global AUM reaching approximately $3.5 trillion—representing roughly 17% year-over-year growth and solidifying the asset class’s position as a cornerstone of institutional portfolios.[4] Capital deployment accelerated to $592.8 billion in 2024, up 78% from prior-year volumes, with momentum carrying into 2025 despite tariff-induced uncertainty that temporarily dampened M&A-driven deal flow. Industry projections now anticipate the market reaching $5 trillion by 2029, driven by continued bank retrenchment and expanding institutional demand.[5]
Yet beneath the surface of aggregate growth, 2025 revealed significant structural tensions. Non-accrual rates for flagship corporate lending funds averaged 2.2%, with weighted-average non-accruals at 1.8%—levels consistent with historical experience but elevated relative to the benign credit environment of 2021-2022. Interest coverage ratios across BDC portfolios deteriorated to approximately 2.0x, with an increasing percentage of portfolio companies falling below this threshold, signaling heightened credit risk compared to public market equivalents.
The Blue Owl Controversy: November’s aborted merger between Blue Owl Capital Corporation (OBDC) and its non-traded affiliate OBDC II crystallized investor concerns about private credit’s valuation infrastructure and liquidity provisions. The proposed transaction would have restricted investors in the $1.7 billion OBDC II from redemptions until deal closure, even as the merger implied approximately 20% paper losses based on where the publicly traded OBDC shares were trading relative to net asset value.[6]
The announcement triggered a 6% decline in Blue Owl Capital’s parent company shares and prompted investor litigation alleging material misstatements about redemption pressures and liquidity conditions. The boards ultimately terminated the merger on November 19, citing ‘current market conditions,’ with OBDC II reinstating its tender program for the first quarter of 2026.[7] The episode highlighted the ‘valuation gap’ between privately held marks and public market skepticism—a tension that may intensify as semi-liquid structures face increased redemption pressures in a potentially volatile 2026.
The First Brands Crisis: Asset-Based Lending’s Stress Test
The September bankruptcy of First Brands Group evolved from an apparent restructuring into a watershed moment for middle market credit discipline when November fraud allegations detailed a multi-billion dollar scheme involving systematically manipulated invoices, double-pledged collateral, and massive fund misappropriation. The lawsuit filed by interim management accused founder Patrick James of ‘grievous misconduct,’ alleging he fraudulently secured billions in financing while diverting over $700 million to himself and affiliated entities between 2018 and 2025.[8]
The forensic audit by Alvarez & Marsal uncovered systematic manipulation of invoices to secure asset-based financing. In one instance cited in court filings, a sales invoice initially showing $179.84 was later altered to $9,271.25—fifty times the original amount. The company allegedly submitted fraudulent invoices to secure at least $2.3 billion in off-balance-sheet financing liabilities, with amounts ‘not accurately reflecting a customer’s order’ and in many cases standing at ten or more times higher than actual orders.[9]
The fallout extended across the lending ecosystem. Major creditors including UBS O’Connor, Jefferies, Raistone Capital, Katsumi Global, and a joint venture between Norinchukin Bank and Mitsui & Co. reported exposures totaling billions. Jefferies CEO Rich Handler stated publicly that the bank believed it was ‘defrauded’ by First Brands. Regional banks also suffered, with First Citizens Bancshares and South State disclosing charge-offs of $82 million and $32.2 million respectively. A U.S. bankruptcy judge approved a $7 million budget for an independent examiner to probe the fraud allegations.[10]
The Federal Reserve’s November Financial Stability Report explicitly cited an ‘auto parts supplier’ bankruptcy as evidence of systemic risks posed by opaque off-balance-sheet financing—elevating First Brands from an operational failure to a financial stability concern. For asset-based lenders, the episode underscored the inadequacy of periodic field exams and borrower-provided certificates in detecting sophisticated fraud, prompting industry-wide reassessment of collateral verification protocols.
Asset-Based Lending’s Ascendance
Despite—or perhaps because of—the First Brands fallout, asset-based lending emerged as one of 2025’s most compelling growth stories. The ABL market demonstrated strong activity levels throughout the year, with clearing banks performing particularly well in the mid-market space by offering competitive pricing alongside complementary banking products.[11] Industry projections now estimate the global ABL market will reach $1.3 trillion by 2030, growing at a compound annual rate of approximately 10.3%.[12]
Non-recourse, off-balance-sheet structures proved particularly popular, along with hybrid asset-based lending and cash flow offerings. Several new fund-backed asset-based lenders launched during 2025, recruiting established ABL professionals with demonstrable track records to lead origination efforts. According to a Preqin survey, 58% of institutional investors indicated they would prioritize ABL strategies in 2025, underscoring the growing institutional appetite for collateral-backed credit.[13]
In a competitive environment for ABL funders, corporate borrowers benefited from lower pricing, larger single-hold levels, and structural enhancements such as accordions that provided meaningful flexibility. Asset-heavy sectors including retail and manufacturing featured prominently in transaction flow, with funders demonstrating increased willingness to underwrite retail credits after several years of hesitancy. The manufacturing sector proved particularly robust, with many of the year’s largest ABL facilities supporting industrials and advanced manufacturing platforms.
Private Equity and M&A: Selective Recovery
Private equity entered 2025 positioned for recovery but found the pathway uneven. In the first half, U.S. PE deal value rose approximately 8% year-over-year to just over $195 billion, while deal volume remained essentially flat—reflecting concentrated success in larger transactions but ongoing stagnation in overall activity.[14] The dynamic improved in the second half: third-quarter deal activity accelerated 4.2% quarter-over-quarter, the first sequential improvement since Q4 2024, as tariff-related uncertainty began to stabilize.[15]
The third quarter proved particularly notable, with PE deal value reaching a record $310 billion as firms capitalized on narrowing valuation gaps and renewed market confidence.[16] Dry powder held by U.S.-based PE funds declined to approximately $880 billion in September 2025 from a record $1.3 trillion in December 2024, indicating meaningful capital deployment. However, the exit environment remained challenged, with PE-backed IPO activity showing signs of life but still well below pre-pandemic norms.
Platform investments rose 14.4% year-over-year as fund managers prioritized new acquisitions to meet capital deployment mandates, while add-on activity largely kept pace with prior-year levels. The backlog of portfolio companies continued to grow, exceeding 30,000 globally by March 2025—47% of which had been held since 2020. If exits were to continue at current pace, industry estimates suggest approximately seven years would be required to clear the backlog of companies held beyond normal four-year periods.
BDC Performance: Yields Attract, Valuations Diverge
The business development company sector delivered on its income mandate in 2025, with leading platforms continuing to generate dividend yields that substantially exceeded traditional fixed-income alternatives. Blue Owl Capital Corporation offered yields exceeding 12% at current trading levels, while Ares Capital Corporation maintained yields approaching 10% backed by its deep credit platform and strong sponsor relationships.[17]
However, the sector’s valuation landscape remained bifurcated. While Main Street Capital traded at a substantial premium to net asset value (1.87x as of October 2025), reflecting investor confidence in its conservative dividend policy and monthly distribution structure, many BDCs traded at meaningful discounts to NAV. This valuation dispersion underscored market skepticism about portfolio marks and uncertainty regarding credit quality in a potentially decelerating economic environment. Interest coverage ratios across BDC portfolios remained compressed at approximately 2.0x, with an increasing percentage of portfolio companies falling below this threshold—indicating heightened fundamental risk relative to public credit markets.[18]
The Regulatory Landscape: Basel Uncertainty and Bank Retrenchment
U.S. banking regulation underwent a material reset in 2025 with new leadership at the Federal Reserve, OCC, and FDIC. On capital requirements, agency leadership made clear that the 2023 Basel III ‘endgame’ proposal would not be finalized in its original form, with Vice Chair for Supervision Michelle Bowman emphasizing the need for greater tailoring and reassessment of the broader capital framework.[19] An initial step occurred in November with finalization of an interagency rule revising the enhanced supplementary leverage ratio for U.S. GSIBs, but regulators indicated additional capital changes are expected in 2026.
The regulatory overhang continued to drive bank retrenchment from capital-intensive lending, creating structural tailwinds for private credit expansion. Basel IV’s stricter risk-weighting requirements and the broader regulatory uncertainty prompted banks to increasingly partner with private credit managers rather than retain credit risk on balance sheet. Notable partnerships proliferated, including collaborations between major banks and alternative asset managers to originate and distribute middle market loans through joint platforms.[20]
Tariffs and Supply Chain Disruption
The Trump administration’s tariff policies reshaped the operating environment for middle market companies throughout 2025. According to McKinsey survey data, 82% of companies reported their supply chains were affected by new tariffs, with 20-40% of supply chain activity impacted in some way. The effects proved most pronounced in supplier and material costs (39% of respondents) and distribution costs (24%), with consumer goods companies reporting the highest sector impact at 43% of activities affected.[21]
Average U.S. import tariffs surged to nearly 20% by Q3 2025, up from 1.5% a year earlier, prompting manufacturers to adapt with creative cost-reduction strategies including first-sale customs valuation, dynamic HTS coding, and duty-drawback programs. Reshoring momentum accelerated, with 69% of manufacturers now reshoring at least part of their supply chain due to trade policies, tariffs, and government incentives.[22] For middle market lenders, these dynamics created both challenges—as borrower margins faced pressure from elevated input costs—and opportunities, as working capital needs expanded amid supply chain restructuring.
Factoring and Receivables Finance: Steady Expansion
The global invoice factoring market continued its expansion trajectory, growing from $3.09 trillion in 2024 to an estimated $3.46 trillion in 2025 at a CAGR of 11.9%. Industry projections anticipate continued growth to $5.34 trillion by 2029, driven by rising fintech solution adoption among small and medium enterprises, expanding e-commerce activity, and increased demand for alternative financing sources among MSMEs.[23]
Technological advancements continued reshaping the factoring landscape, with AI-driven risk scoring, blockchain-based invoice tokens, and straight-through processing gaining adoption among leading providers. Non-bank financial companies recorded stronger growth rates than traditional bank-affiliated factors, leveraging cloud-native platforms and real-time APIs to accelerate underwriting and approval processes. The competitive dynamics between bank and non-bank factors intensified as digital capabilities increasingly determined market share.
Items to Consider for 2026
Transition to Continuous Collateral Monitoring. The First Brands fraud demonstrates that periodic field exams and borrower-provided certificates are insufficient for detecting sophisticated manipulation. Market participants may benefit from evaluating real-time, technology-enabled collateral verification systems and independent third-party audit protocols that can identify anomalies before they metastasize into material losses.
Scrutinize Liquidity Provisions in Private Credit Structures. The Blue Owl episode serves as a reminder to evaluate carefully the capital sources and redemption structures of private credit investments. Borrowers and their advisors should assess whether lender liquidity profiles align with facility terms, particularly for platforms with significant retail investor participation or semi-liquid fund structures.
Prepare for Continued Fed Policy Uncertainty. The unprecedented divisions within the FOMC and the impending leadership transition suggest monetary policy may remain unpredictable through 2026. Stress-testing portfolios across various rate scenarios—including the possibility of renewed tightening if inflation persists—appears prudent given the Committee’s internal discord.
Capitalize on Asset-Based Lending’s Structural Advantages. The ABL market’s growth trajectory and favorable competitive dynamics create opportunities for borrowers seeking flexible, collateral-backed financing. As banks continue retreating from capital-intensive lending and private credit managers expand ABL strategies, the pricing environment may remain attractive for qualified borrowers with strong asset coverage.
Monitor the Private Equity Exit Backlog. With over 30,000 portfolio companies globally and nearly half held since 2020, the PE industry faces mounting pressure to generate realizations. This dynamic may create both refinancing challenges for portfolio companies and opportunities for secondary market participants as sponsors seek creative liquidity solutions.[24]
Build Tariff Resilience into Credit Underwriting. With tariffs affecting 82% of surveyed supply chains and average import duties reaching 20%, lenders may benefit from incorporating supply chain exposure and tariff sensitivity into their credit analysis frameworks. Borrowers with demonstrated ability to pass through costs, diversified supplier bases, or domestic manufacturing footprints may warrant favorable consideration.
Conclusion
The year 2025 will be remembered as a period when private credit’s decades-long expansion encountered its most significant structural tests. The asset class demonstrated resilience in aggregate—reaching $3.5 trillion globally while continuing to attract institutional capital—yet individual episodes exposed vulnerabilities in valuation transparency, liquidity management, and fraud detection that had accumulated during years of favorable conditions.
For middle market participants, the year’s lessons are clear: growth without discipline creates fragility, and the collateral-backed structures that underpin asset-based lending require continuous verification rather than periodic review. The Federal Reserve’s fractured easing cycle provided relief for floating-rate borrowers but left fundamental questions about 2026 monetary policy unanswered. Tariff disruptions reshaped supply chains and created both challenges and opportunities across the lending ecosystem.
As 2026 approaches, the middle market debt landscape stands at an inflection point. Private credit’s trajectory remains positive, but the industry must demonstrate that its risk management infrastructure can match its growth ambitions. Asset-based lenders have an opportunity to capitalize on their structural advantages while implementing the enhanced monitoring protocols that the First Brands scandal demands. And all market participants must navigate a regulatory and monetary policy environment where uncertainty may be the only constant. Success will favor those who pair opportunistic deployment with disciplined underwriting—a balance that 2025 proved more difficult to achieve than many anticipated.
Footnotes
[1]Fed interest rate decision December 2025 – CNBC
[2]Federal Reserve Board – Implementation Note issued December 10, 2025
[3]Divisions at the Fed that defined 2025 are expected to carry into 2026 – Yahoo Finance
[4]Global private credit market reaches US$3.5 trillion AUM – Alternative Credit Council
[5]Private Credit Outlook: Estimated $5 Trillion Market by 2029 – Morgan Stanley
[6]Blue Owl calls off merger of its two private credit funds – CNBC
[7]Blue Owl faces investor suit over BDC redemptions – InvestmentNews
[8]First Brands founder accused of looting company – Fortune
[9]First Brands Collapse Spurs Scrutiny of Off-Balance-Sheet Financing – ABF Journal
[10]First Brands Judge Approves Examiner to Probe Fraud Allegations – Bloomberg Law
[11]Asset-based lending wrapped 2025 – Addleshaw Goddard
[12]Asset-based Lending Industry Worth $1.3 Trillion by 2030 – GlobeNewswire
[13]The growth of asset-based finance in private credit markets – Macfarlanes
[14]Private equity: US Deals 2026 outlook – PwC
[15]Capital Markets Update Q3 2025 – Capstone Partners
[16]Private Equity Pulse: key takeaways from Q3 2025 – EY
[17]5 Best BDC Stocks to Invest in 2025 – The Motley Fool
[18]Why private credit remains a strong opportunity – J.P. Morgan Private Bank
[19]2025 Bank Regulatory Roundup – Freshfields
[20]Private Credit Outlook 2025 – With Intelligence
[21]Supply chain risk pulse 2025: Tariffs reshuffle global trade priorities – McKinsey
[22]2025 Manufacturing Update: Overcoming Challenges – Eide Bailly
[23]Invoice Factoring Market Report 2025 – Research and Markets
[24]Global M&A trends in private equity: 2025 mid-year outlook – PwC
