Slowing Growth, Rising Stress: What the Middle Market’s Diverging Credit Signals Mean for Lenders and Sponsors

Lincoln International’s Private Market Index (LPMI) recorded full-year 2025 EBITDA growth of 4.7% across its middle market portfolio, an improvement over 2024’s 3.5% but a figure that masks a pronounced deceleration across the year.¹Year-over-year EBITDA growth stood at 6.5% in the second quarter, slipped to 5.2% in the third, and ended 2025 at 4.7% in the fourth. Approximately two-thirds of the roughly 1,500 companies tracked in the LPMI reported positive EBITDA growth in Q4, meaning that a meaningful minority did not.¹ Enterprise values in the index rose 1.9% quarter-over-quarter in Q4, a gain driven almost entirely by earnings improvement rather than multiple expansion — itself notable, because it suggests the earnings growth is real but its breadth is narrowing.

At the same moment, KBRA’s Middle Market Default Monitor — a forward-looking gauge that captures borrowers in active payment default alongside those assessed as likely to default absent sponsor or lender intervention — stood at 3.4% by borrower count and 2.0% by notional debt value as of year-end 2025, edging down from 3.5% by count in the third quarter.² Crucially, KBRA attributed that modest decline not to improving credit quality but to a record number of new assessments completed in Q4, which expanded the denominator. The underlying composition of the monitor — 17 outright payment defaults and 64 CCC-minus assessments among an 81-company pool — tells a more cautious story than the headline rate implies.²

The coexistence of positive but decelerating aggregate earnings and a persistently elevated default monitor is the central paradox facing the middle market private credit ecosystem heading into 2026. Understanding where the growth is concentrated, where the stress is accumulating, and why standard portfolio metrics can obscure both is essential for every participant in the capital stack.

Where the Earnings Growth Is Concentrated

The 4.7% EBITDA growth figure for 2025 is a weighted average across six industry sectors tracked by Lincoln, and the sector-level data reveal substantial dispersion in enterprise value performance. Healthcare companies in Lincoln’s index posted a 3.2% enterprise value gain in Q4 and 8.9% for the full year, while industrials contributed 2.2% quarterly and 10.6% annually, supported in part by renewed policy emphasis on reshoring and elevated defense spending.⁴ Business services companies generated 9.3% enterprise value growth across 2025, and technology, despite slowing sharply in Q4 amid uncertainty about AI disruption and recurring revenue sustainability, still posted 8.6% for the year.

Consumer-facing companies lagged across every time frame. Consumer enterprise values grew just 1.9% in Q4 and 6.2% for the year — the weakest performance of any sector tracked by Lincoln — as persistent inflation, tariff-driven input cost pressures, and declining consumer confidence weighed simultaneously on margins and borrower creditworthiness.⁴ Lincoln noted specifically that consumer companies saw greater reliance on payment-in-kind interest and higher loan-to-value ratios, two metrics that typically precede formal credit deterioration.

The implication for portfolio-level interpretation is important. If technology, healthcare, industrials, and business services are each growing enterprise values by 9% to 11% and collectively represent a large share of a direct lending portfolio’s dollar exposure, the weighted average can appear healthy even as consumer and other stressed sectors pull in the opposite direction.

The Stress Signals KBRA Is Tracking

KBRA’s Q4 2025 borrower surveillance compendium, based on 3,649 middle market corporate credit assessments completed during 2025 and covering over $1 trillion in private direct lending debt, identified several developments that sit uncomfortably alongside the positive headline EBITDA trend.²

The share of borrowers with a sub-1.0x interest coverage ratio declined to 25% in Q4 2025, the lowest reading since the third quarter of 2024, while the median interest coverage ratio held steady at 1.5x.² One borrower in four generating less cash than required to cover interest expense is a material stress indicator even in a period of positive aggregate earnings growth, because it identifies a population whose ability to service debt depends on sponsor support, amendment forbearance, or PIK elections rather than operating cash flow.

Downgrades outpaced upgrades for two consecutive years in KBRA’s assessed portfolio, contributing to a growing cohort of borrowers that KBRA described as vulnerable to even minor operational or macroeconomic headwinds and increasingly reliant on sponsor or lender support.² Multilevel downgrades — those spanning more than one rating category — accelerated 2.9 times quarter-over-quarter in Q4, a development KBRA linked directly to cases where sponsor and lender liquidity backstops had become exhausted. The pattern underscores a recurring dynamic in stressed middle market credit: deterioration can remain concealed behind active support structures for several quarters and then accelerate quickly once that support is withdrawn.

The share of borrowers reporting declining EBITDA rose for two consecutive years and stood at 22% as of year-end 2025, even as median EBITDA growth remained in double digits when measured on a compound basis across KBRA’s assessed universe.² The divergence between median and declining-company metrics is precisely the distributional phenomenon that aggregate statistics fail to capture.

Leverage Is Rising Even as Earnings Grow

Lincoln’s data surfaced another dynamic that complicates the optimistic headline reading: leverage across the LPMI portfolio increased by approximately 0.5 times from deal inception to the present across all vintage years, the inverse of what would be expected in a period of genuine, broad-based earnings improvement.¹ For the 2019 and 2020 vintage cohorts specifically, leverage increases were closer to 1.0 times from inception — deals that may have been underwritten at reasonable leverage levels but that have not organically deleveraged through earnings growth, leaving them facing maturities with debt loads that have grown relative to earnings rather than shrunk.

Lincoln identified approximately $24.1 billion in debt foreclosed by lenders taking control of businesses from sponsors during 2025, against just $13.6 billion in total change-of-control transactions across the three preceding years combined.¹ Nearly three-quarters of those change-of-control transactions related to 2021 and 2022 vintage deals — the cohort underwritten at peak valuations and leverage levels during the period of ultra-low rates. As that vintage continues to age toward maturity, the pipeline of potential restructuring situations is expanding even though aggregate metrics appear relatively stable.

Why Aggregate Metrics Mislead in a Bifurcated Environment

The tendency to evaluate portfolio health through weighted averages — median EBITDA growth, portfolio-level default rates, asset-class return figures — is structurally embedded in how private credit managers communicate with limited partners and regulators. These averages are accurate descriptions of the central tendency but poor predictors of tail outcomes, and the current middle market environment is one where the tails are increasingly divergent.

Lincoln’s observation that two-thirds of its portfolio companies showed positive EBITDA growth in Q4 implies that roughly one-third did not, yet the portfolio-level figure of 4.7% growth reflects the magnitude distribution of outcomes, not merely that underperforming minority.¹ A portfolio with a large cluster of companies growing earnings by 8% to 10% and a smaller cluster declining by comparable magnitudes will report a healthy average while concealing meaningful credit deterioration in the underperforming cohort.

Moody’s analysis of corporate default risk published in April 2026 underscored this fragmentation theme, noting that while average credit risk indicators pointed toward easing defaults through mid-2026, the credit landscape was “fragmented and fragile,” with smaller, unrated firms exhibiting higher and more persistent default risk than the headline public market data would suggest.³ Moody’s estimated that the private credit default rate in 2025 likely ranged between 1.6% and 4.7% depending on whether distressed exchanges are included, with distressed restructurings accounting for approximately 65% of all defaults in 2025 — meaning that the measured default rate is highly sensitive to definitional choices and that the true rate of credit stress may differ substantially from either bound.³

The illiquidity of private credit compounds this interpretive challenge. Unlike public credit markets, where bond and loan prices reflect real-time assessments of credit quality, private loans are marked at valuations determined quarterly, and those marks may lag fundamental performance by one or more quarters. Lincoln reported that the average fair value of loans tracked by its Senior Debt Index decreased just 0.1% from the third to fourth quarter of 2025, even as amendment activity increased 13% quarter-over-quarter, with maturity extensions and covenant holiday activity rising 14% and sponsor infusion activity rising 31%.¹ High fair values and elevated amendment volumes are not contradictory, but reading only the fair value data would significantly understate the degree of active credit management required to sustain those marks.

Implications for Capital Stack Participants

For sponsors, the diverging performance environment rewards sector concentration in healthcare, industrials, and business services while penalizing consumer and import-dependent manufacturing exposure. The funds best positioned for 2026 are those with operational resources capable of intervening in underperforming portfolio companies before earnings deterioration converts to covenant defaults, because the KBRA data suggests that the window between visible stress and change-of-control restructuring has shortened.

For lenders, the signal from KBRA’s data is that portfolio-weighted average interest coverage ratios and aggregate default rates should be supplemented with distributional analysis. The fact that 25% of KBRA-assessed borrowers operated below 1.0x interest coverage as of Q4 2025, while the median borrower maintained 1.5x, means that the median is not a reliable guide to tail risk.² Engagement with the sub-1.0x cohort — through covenant discussions, amendment negotiations, or operational support — is more effective when initiated proactively rather than reactively.

For restructuring and turnaround advisors, the current environment is generating a pipeline of potential assignments that is larger than aggregate default rate data would indicate. The 22% of KBRA-assessed borrowers reporting declining EBITDA, combined with the 25% below 1.0x interest coverage, defines a population that is approaching rather than already in formal distress.² Many of these situations will resolve through amendment, extension, or sponsor support, but a portion will require more substantive intervention. The optimal window for operational restructuring typically precedes formal default by several quarters, which positions the current environment as one where early engagement creates materially better outcomes than waiting for a default event to trigger formal proceedings.

Conclusion

The middle market in 2025 and early 2026 is neither uniformly healthy nor uniformly stressed. EBITDA growth decelerated every quarter of 2025, ending the year at 4.7% on a full-year basis — a positive figure that nonetheless reflects a narrowing breadth of performance improvement.¹ KBRA’s default monitor, at 3.4% by count with 22% of assessed borrowers reporting EBITDA declines and 25% operating below 1.0x interest coverage, describes a market with significant stress in specific cohorts even as the headline aggregate remains positive.² Moody’s framing of credit risk as “fragmented and fragile” captures the essential challenge: easing average default rates should not be read as a broad reduction in credit risk when the underlying distribution is bifurcating and when structural features of private credit — mark-to-market lags, PIK elections, amendment forbearance — can defer but not eliminate the reckoning.³

Participants who evaluate this market through portfolio averages will consistently underestimate the tail risk concentrated in consumer-exposed, import-dependent, and high-leverage 2021-2022 vintage borrowers. Participants who disaggregate to the company level, monitor interest coverage distributions rather than weighted averages, and engage proactively with the distressed minority will be better positioned to protect capital and, where applicable, to identify the restructuring opportunities that are already materializing in the data.

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Footnotes

1. Lincoln International, “The Lincoln Private Market Index Ends the Year with its Slowest Quarter of Growth in 2025,” February 11, 2026 (Full-year 2025 EBITDA growth of 4.7%, decelerating from 6.5% in Q2 to 5.2% in Q3 to 4.7% in Q4; LPMI rose 1.9% in Q4; covenant default rate flat at 3.2%; amendment activity up 13% quarter-over-quarter in Q4; maturity extensions up 14%; sponsor infusions up 31%; leverage increases of approximately 0.5x from deal inception across all vintages; $24.1 billion in lender change-of-control foreclosures in 2025 vs. $13.6 billion in the prior three years combined; approximately two-thirds of portfolio companies posted positive EBITDA in Q4.)
2. KBRA, “Private Credit: Q4 2025 Middle Market Borrower Surveillance Compendium: Stability at the Median, Stress at the Margins,” February 25, 2026 (KMDM rate 3.4% by count and 2.0% by value at Q4 2025; 81 companies in monitor comprising 17 payment defaults and 64 CCC-minus assessments; sub-1.0x interest coverage ratio at 25% of borrowers, lowest since Q3 2024; median ICR steady at 1.5x; 22% of borrowers reporting EBITDA declines; multilevel downgrades up 2.9x quarter-over-quarter; downgrades outpaced upgrades for two consecutive years; 3,649 assessments completed in 2025 covering over $1 trillion in direct lending debt.)
3. Moody’s, “America’s Corporate Credit Is at a Tipping Point: Default Rates Are Easing. Credit Risk Is Fragmented and Fragile Across Markets,” April 28, 2026 (Private credit default rate in 2025 estimated at approximately 1.6% to 4.7% depending on inclusion of distressed exchanges; distressed restructurings accounted for approximately 65% of all defaults in 2025; Moody’s baseline GDP growth forecast for 2026 of approximately 1.5%, described as just above historical “stall speed”; credit risk described as “fragmented and fragile.”)
4. Lincoln International, “Q4 2025 Lincoln Private Market Index,” February 11, 2026 (Sector enterprise value performance in 2025: Healthcare +8.9% YTD; Industrials +10.6%; Business Services +9.3%; Technology +8.6%; Consumer +6.2%, last place in all periods; Technology +0.6% in Q4 specifically, slowest of six sectors; Consumer companies showed greater reliance on PIK interest and higher LTVs in 2025.)