Week Ending January 4, 2026
2026 Opens with Cautious Optimism as ABL Sector Embraces “Trust but Verify” Mandate
The week ending January 4, 2026, offered a subdued start to the new year as dealmakers returned from the holiday break, but the relative quiet belies a market bracing for a pivotal twelve months. Following a turbulent close to 2025—punctuated by the Federal Reserve’s December rate cut and the shockwaves from the First Brands fraud scandal—middle market participants are entering a year that industry observers increasingly characterize as one of differentiation.
While transaction activity was somewhat light over the New Year’s holiday, the structural themes for 2026 have come into sharp focus. The consensus view centers on a maturing wall of 2021-vintage debt approaching refinancing windows, heightened scrutiny on private credit valuations following high-profile BDC liquidity events, and a banking sector still navigating Basel III implementation delays. For asset-based lenders specifically, the First Brands collapse has triggered what one industry veteran described as a “trust but verify” mandate that promises to reshape due diligence practices across the sector.
Federal Reserve Signals January Pause After December Cut
The Federal Reserve’s decision on December 10 to lower the federal funds rate by 25 basis points—bringing the target range to 3.50%–3.75%—marked its third reduction of 2025.¹ However, the path forward for 2026 appears far less linear than the easing cycle seen in late 2025. Current overnight SOFR rates of approximately 3.87% reflect the Fed’s still-restrictive stance.²
Financial markets expect the Fed to hold steady at its January 28 meeting, with the CME FedWatch tool showing roughly 77% probability of no action.³ Goldman Sachs Research anticipates a “skip” in January before potential cuts resume in March and June, targeting a terminal rate of 3.0%–3.25% by year-end.⁴ However, divergent views persist: Moody’s Analytics Chief Economist Mark Zandi projects three cuts in the first half of 2026, driven by labor market weakness and political pressure on the central bank.⁵
Adding uncertainty to the monetary policy outlook, Fed Chair Jerome Powell’s term expires in May 2026, with four new regional Fed presidents rotating onto the FOMC in January.⁶ The incoming presidents from Cleveland, Philadelphia, Dallas, and Minneapolis generally carry a more hawkish orientation than their outgoing counterparts. For middle market borrowers, this translates to SOFR-based financing costs stabilizing near current levels through at least the first quarter—significantly lower than 2024 peaks but still elevated relative to pre-pandemic norms.
Asset-Based Lending: The Post-First Brands Reckoning
The fallout from the First Brands Group bankruptcy continues to dominate conversations across the asset-based lending community as the new year begins. The allegations of systematic fraud—including $2.3 billion in missing off-balance-sheet financing, double-pledged receivables, and invoices manipulated fifty-fold—have shattered assumptions that traditional field examinations provide sufficient fraud protection.⁷
The Federal Reserve’s explicit citation of the auto parts supplier’s collapse in its November Financial Stability Report elevated these concerns from operational failures to systemic risks.⁸ Industry leaders are responding with a comprehensive overhaul of verification practices. As one industry observer noted: “The only balance sheet number I am sure about is my loan balance. Cash is still king, and often nothing works better than following the cash during field examinations.”⁹
Looking ahead, the ABL sector is poised for a technological transformation. Lenders are expected to aggressively adopt AI-driven continuous monitoring tools to validate invoices and inventory in real-time, moving beyond periodic “snapshots” that failed to detect the alleged multi-year scheme at First Brands. The shift from annual field exams to continuous verification represents the most significant operational change in ABL practices in decades.
Despite these headwinds, the broader ABL market fundamentals remain compelling. Industry analysis shows that 2025 delivered favorable conditions for corporates, with lower pricing, larger single hold levels, and flexible accordion features making the borrower experience highly competitive.¹⁰ Asset-heavy sectors—particularly retail and manufacturing—featured prominently in 2025 deal activity, with funders showing renewed willingness to underwrite retail credits after years of hesitancy.
Whether these borrower-friendly conditions persist into 2026 remains uncertain as funders shift focus from book building to income optimization. Private credit’s continued push into the ABL market, with several new fund-backed asset-based lenders launching in 2025 and recruiting established industry leaders, suggests intensifying competition for middle market credits.¹¹
Private Credit: Liquidity and Valuation Scrutiny Intensifies
The reverberations of Blue Owl Capital’s terminated merger between its public and private funds in November 2025 continue to shape the outlook for non-traded business development companies (BDCs). The episode—in which Blue Owl halted redemptions for OBDC II investors pending a merger that was subsequently canceled due to “current market conditions”—highlighted tensions between private valuation stability and public market liquidity demands.¹²
The terminated merger, followed by investor litigation alleging misleading statements about redemption pressure, underscores the structural challenges facing semi-liquid private credit vehicles.¹³ OBDC II indicated plans to reinstate its quarterly tender program in Q1 2026, subject to board approval—a development that will be closely watched by the broader BDC community.
Entering 2026, investors are demanding greater transparency regarding gating mechanisms and valuation methodologies. Morgan Stanley’s private credit outlook notes that semi-liquid vehicles now command almost a third of the $1 trillion U.S. direct lending market, making their structural integrity critical to overall market stability.¹⁴ The bifurcation between top-tier managers with diverse funding sources and smaller platforms reliant on retail capital flows will likely widen throughout the year.
On a more constructive note, credit fundamentals across seasoned BDC portfolios show improvement. Non-accrual rates have trended lower in recent quarters, while the weighted-average interest coverage ratio across middle market loans improved to 2.3x at the end of third quarter 2025, up from 2.0x a year earlier.¹⁵ The combination of declining interest expense and rising EBITDA levels should support improving fundamentals barring any unforeseen macro shock.
M&A Outlook: Selective Recovery Expected
Middle market M&A activity enters 2026 positioned for what industry observers describe as a “selective recovery.” Private equity firms hold more dry powder and aging portfolio companies than during prior large-deal cycles, creating pressure to deploy capital and generate returns for limited partners.¹⁶ However, valuation gaps continue making exits challenging, with the median time to close a private equity fund now stretching to 22 months—up from roughly 16 months in 2020.¹⁷
The pipeline appears more promising than recent quarters suggest. Exit markets gained traction in late 2025, with private equity exit values rising 69% year-over-year in the first half of 2025 and exit counts up 18%.¹⁸ Several high-profile IPO candidates—including major AI firms—are gearing up for potential offerings, signaling broader market reopening.¹⁹
Middle market deals, typically ranging from $25 million to $1 billion, remain the core of private equity activity.²⁰ With lower leverage and a focus on operational performance, these transactions continue driving consistent value creation. Strategic buyers are re-entering the market, and sponsors are becoming more flexible on valuations, laying groundwork for a more balanced transaction landscape.
Regulatory Environment: Basel III Recalibration Creates Opportunities
The regulatory landscape continues evolving in ways that favor alternative lenders. U.S. regulators made clear in 2025 that the original Basel III “endgame” proposal would not be finalized as initially drafted, with Fed Vice Chair for Supervision Michelle Bowman emphasizing greater tailoring and reassessment of the broader capital framework.²¹ Additional capital changes are expected throughout 2026, with finalization potentially occurring by year-end and implementation beginning in 2027.
For middle market participants, continued regulatory uncertainty around bank capital requirements maintains private credit’s competitive advantages. As regional banks continue evaluating capital-intensive asset portfolios, opportunities persist for non-bank ABL providers and direct lenders to capture credits that no longer fit traditional bank balance sheets.
Items to Consider
Stress Test for a “Skipped” Cut. With a January Fed pause highly likely, borrowers anticipating immediate rate relief should adjust Q1 cash flow forecasts. Liquidity models should account for SOFR remaining near 3.6%–3.9% through at least March, with gradual declines anticipated through year-end.
Audit Off-Balance-Sheet Exposures. In light of the First Brands allegations, lenders should conduct immediate reviews of borrowers with complex subsidiary structures or significant off-balance-sheet financing arrangements. A simple “certificate of no debt” no longer constitutes sufficient due diligence. Real-time collateral verification and independent invoice validation should become standard practice.
Prepare for the 2021 Refinancing Wave. Loans originated during the heavy deal flow of 2021 are entering their fifth year, with many approaching maturity or covenant reset dates. With exit activity still recovering, lenders should proactively engage sponsors on amend-and-extend terms before maturity dates trigger technical defaults.
Monitor BDC Liquidity Developments. The Blue Owl episode highlighted structural tensions in semi-liquid vehicles. Watch for Q1 tender offer results across non-traded BDCs as a barometer of investor sentiment and potential redemption pressure on the broader market.
Assess Private Credit Manager Differentiation. As the market matures, the gap between disciplined managers with strong origination capabilities and those facing competitive pressure will widen. Focus on platforms with demonstrated workout experience, sector expertise, and technological infrastructure for continuous portfolio monitoring.
Conclusion
As the middle market emerges from its holiday pause, the themes of 2026 are already inscribed in the volatility of late 2025. The era of historically low rates has ended, but the era of superficial diligence has also officially concluded. The coming year will reward those who combine disciplined credit underwriting with the technological infrastructure to verify it continuously.
Whether navigating Fed policy uncertainty, ensuring collateral integrity post-First Brands, or managing liquidity expectations in semi-liquid structures, 2026 will be the year where operational execution separates successful participants from those caught unprepared. The middle market’s fundamental strengths—diverse funding sources, sponsor relationships, and specialized sector expertise—remain intact. Success will accrue to those who demonstrate the discipline and vigilance these challenging conditions demand.
Footnotes
- Fed Cuts Rates for the Third Time This Year – Charles Schwab
- Secured Overnight Financing Rate (SOFR) – Federal Reserve Bank of St. Louis
- Fed Interest Rate Cut Bets Shift for January – TheStreet
- Fed Outlook 2026: Rate Forecasts and Fixed Income Strategies – iShares
- Economist Mark Zandi Sees Fed Surprising with Three Rate Cuts in First Half of 2026 – CNBC
- Big Changes Are Coming to the Federal Reserve in 2026 – Yahoo Finance
- First Brands Faces Investigation into Double Financing of Receivables, Inventory – Global Trade Review
- Middle Market Debt Weekly: First Brands Collapse Spurs Scrutiny of Off-Balance-Sheet Financing – ABF Journal
- The First Brands Collapse: A Cautionary Tale – Secured Finance Network
- Asset-Based Lending Wrapped 2025 – Addleshaw Goddard
- Asset-Based Lending Wrapped 2025 – Lexology
- Blue Owl Capital Corporation and Blue Owl Capital Corporation II Announce Termination of Merger – PR Newswire
- Blue Owl Faces Investor Suit Over BDC Redemptions, Liquidity, Merger – InvestmentNews
- Private Credit 2026 Outlook – Morgan Stanley Investment Management
- Do the Recent Bankruptcies of First Brands and Tricolor Suggest Trouble Ahead in Private Credit? – Cambridge Associates
- US Deals 2026 Outlook – PwC
- Middle-Market Private Equity Outlook: Momentum Builds for 2026 – Suntera
- Middle-Market Private Equity Outlook: Momentum Builds for 2026 – Suntera
- 2026 Set to Be a Bumper Year for M&A, IPOs – Semafor
- Middle-Market Private Equity Outlook: Momentum Builds for 2026 – Suntera
- 2025 Bank Regulatory Roundup and What to Look for in 2026 – Freshfields
