Private credit is poised to grow further in 2025 as investor demand for this exposure remains strong. The interplay between direct lending in the upper middle markets and the BSL market has become a hot topic, with rapid spread compression in both lending markets as they compete for assets.

Last year, we published a commentary centering on documentation among BSL issuers that were refinanced into private credit. However, 2024 also marked the revival of the U.S. BSL market as it competed for new deals. With funding opportunities widely open in both the BSL and private credit markets, this report puts a spotlight on the reverse flow: private loans refinanced into the syndicated leveraged loan market in recent years. These unrated-to-rated transitions achieved a median spread reduction of 250 basis points (bps). While the sample size for these instances is small, the evidence suggests that the threshold to transition to the BSL market remains high, marking it viable for only a relatively select group. Strong growth, performance stability, and significant deleveraging played a role in preparing them for the transition.

More broadly, speculative-grade issuers in the U.S. and Canada--based on our sample of approximately 1,000 public and private companies--continue to grow top-line revenues, though profit margins are eroding. Lastly, new first-lien debt issued in fourth-quarter 2024 has an average estimated recovery of 64%, largely unchanged from the prior quarter but well below historical actual recoveries of 75%-80%.

Click here to access many of the charts and tables in an interactive format.

Growing Beyond Private Credit: The Shift To BSL

A steady flow of corporate borrowers--mostly at the lower end of the rating scale--is seeking funding proposals from private credit and institutional loan markets. They are pursuing funding opportunities through dual-track approaches that compare the attractiveness of syndicated lending with private credit options. A favorable credit outlook, net institutional loan supply shortfalls, and healthy all-in yields have driven U.S. syndicated loan spreads to their tightest levels since the Great Recession for lower-rated credits, allowing the market to attract high-quality issuers back to the syndicated loan markets.

This report examines 23 companies, all backed by financial sponsors, that transitioned from the private market to the broadly syndicated loan space. To ensure good visibility into the performance before and after the transition, we narrowed our sample to companies from our CE universe. CEs reflect our view of these companies' credit quality, as they were obligors of loans held by middle-market collateralized loan obligations we rate. In many instances, the initial CE was assigned years ahead of the transition.

The transition from private to BSL gained momentum in early 2024, with debt structures typically featuring a seven-year first-lien institutional term loan from $400 million-$1.3 billion. While refinancing is the predominant transaction type, it's not the only one. At least one borrower raised a term loan in the syndicated market to fund a leveraged buyout, having previously borrowed in the direct lending market with a unitranche facility.

The norm for these structures is still first-lien-only, with very few deals having any junior debt layer. In at least one case, the second-lien term loan simply replaced a downsized portion of the first-lien facility. Finally, delayed draw options are becoming more popular, appearing in over half of private loans and 40% of BSLs. This feature mainly supports ongoing tuck-in acquisitions, giving borrowers the flexibility they want in payment terms and structures.

When the deals moved from private to the syndicated loans, spreads dropped significantly, a key consideration in this transition. The deals reduced a median of 250 bps, with seven of the 23 companies cutting loan spreads by at least 300 bps by moving to the BSL market. There wasn't a clear tie between company size and the amount of spread saved, but the credit rating at transition did matter (see chart 1). Thanks to last year's record-tight leveraged loan spreads, entities rated 'B' secured a median saving of 290 bps, 90 bps more than their lower-rated 'B-' counterparts. Among the biggest winners was Wood Mackenzie, a data analytics, research, and consulting services firm, which refinanced its S+675, $1.2 billion unitranche term loan with a $1.3 billion term loan B at S+350.

Flexibility with documentation also influenced the decision to transition. Our findings confirm a trend toward looser covenant structures, as every institutional loan that transitioned is covenant-lite--free of financial maintenance covenants embedded in all the private credit loans in our sample.

That said, we noticed some tightening in other areas of the loan terms. For instance, one large borrower's term loan revised to include Chewy, J. Crew, and Serta protections. We see this as part of a broader pattern where BSL lenders seek more upfront ways to safeguard against potential liability management transactions (LMTs). Such tightening reduced the disparity in documentation flexibility between the two markets.

At the time of crossover, the median adjusted revenue and EBITDA were $454 million and $84 million, respectively. In many ways, these companies have effectively graduated from the middle market, with their size nearly triple the median adjusted EBITDA of $30 million for the entire universe of U.S. CE companies reviewed in 2024.

However, they still look relatively small within the broader North American speculative-grade portfolio, where the median adjusted EBITDA is about $305 million. The health care, business, and consumer services sectors saw more transitions than others, accounting for about half of our sample and broadly reflecting their already large presence in the CE universe.

Table 1

Before the transition, it was all about growth. On a median basis, companies in our sample boosted sales around 50% and nearly doubled their EBITDA since their initial CE (see chart 2). By the time they crossed over, 87% (or an additional 40% from their starting point) pushed EBITDA above $50 million, a threshold often used to define the middle market.

Many of these companies can be described as serial acquirers, motivated to scale through M&A. Another common strategy often championed by sponsors involves combining portfolio companies to capitalize on synergies, whether leveraging larger purchasing power, trimming redundant corporate costs, or expanding product or geographic diversity. One standout example is Groundworks, a consolidator in residential foundation repair and water management services. Since its initial LBO by affiliates of KKR & Co, Groundworks has successfully integrated acquisitions and rolled out organic greenfield branches, achieving double-digit revenue growth over the last several years in an industry that typically expands at a modest low-single-digit percentage rate.

Chart 2

With such a jump in growth, many companies demonstrated a strong track record of deleveraging (see charts 3 and 4). On a median basis, companies reduced leverage by about 4x, down to 5.7x from 9.8x, from the time of their initial credit estimates to their move to public lending. Smaller entities (EBITDA of less than $100 million EBITDA) drove much of this improvement, as they often started with much higher leverage. Leverage across the board in 2024 was also generally lower. In contrast, gains in interest coverage were more subdued, largely due to the steep rise in benchmark rates between 2022 and 2023, although the median coverage did tick up to 1.6x at transition--again, most notably among smaller companies.

Looking forward, we don't expect the mild jump in leverage since the transition to gain momentum unless there's a wave of aggressive, debt-funded transactions. Likewise, we don't foresee a substantial drop in leverage because financial sponsors back these companies and often maintain high leverage to maximize returns. Periods of strong performance frequently lead to shareholder distributions that help support investment returns.

Chart 3

Chart 4

The path from 'b-' (CEs use lowercase letters to distinguish them from issuer credit ratings) to 'B-' was the most common, which isn't surprising given that 'b-' CEs account for three-quarters of our CE universe. Notably, no issuers with a score below 'b-' moved into the syndicated market. Seven entities with a 'b-' CE score rolled over into a stronger 'B' issuer credit rating. They had a better capital structure, more equity, and reduced cost of borrowing, and also likely benefitted from forward-looking considerations and past credit improvements. While CEs offer a point-in-time credit view based off of historical financials, issuer credit ratings include active dialogue with management and incorporate a forward-looking view--such as operational and expansion plans and expected cost savings from synergies that we expect to materialize over time.

Even with limited operating scale and relatively weak competitive positions, these companies have maintained a steady upward trajectory since transitioning to BSL, growing EBITDA a further 14%. When we plotted year-over-year changes in their 12-month EBITDA margin, three-quarters of these companies were positioned above the diagonal line, indicating profit margin expansion in the 12 months through third-quarter (see chart 5).

Chart 5

They surpassed other small-scale companies in the broader BSL portfolio, and their performance trends align with those of new BSL issuers in the health care, business and consumer services, and technology sectors rated 'B' and 'B-' (our closest comparison group). Among new issuers rated 'B-' in these sectors, median margins increased to 18.0% for the 12 months through third-quarter 2024, up from 14.6% a year earlier. New issuers rated 'B' also rose to 18.9%, compared with 15.0%. Key drivers behind this margin expansion included higher-margin issuer acquisitions and reduced spending on advertising and marketing. One example saw an issuer lock in critical raw material inputs for over a year to mitigate margin risk.

However, persistent labor headwinds and the need to invest in outsized growth remain potential threats. Ratings have stayed stable post-transition, though this could also reflect the short timeframe since the transition.

More competition ahead

For upper-middle-market issuers, our findings indicate that the threshold to transition to the BSL market remains high, marking it viable for only a relatively select group. At the same time, private lenders have demonstrated a strong commitment to holding onto their highest-quality deals, as shown by the narrowing spreads last year, and we expect this trend to continue. Consequently, we anticipate that spreads between the two markets will continue to compress within this segment.

However, BSL issuers at the lower end of credit rating are likely to keep turning to private credit. Private credit lenders have leveraged their flexibility to compete beyond just pricing--offering features like payment-in-kind (PIK) provisions that allow more tailored repayment options.

Despite these dynamics, we believe that overall growth in both markets will hinge more on a rebound in LBO and M&A activity than a competition between the two. While there are signs risk appetite is returning among BSL lenders, their approach remains cautious and selective. We will particularly monitor if LBO deals rated 'B-' will emerge in the BSL market amid the current supply shortage. Securing large deals will remain a critical battleground, and this is particularly important for the private credit space given its smaller typical deal sizes. Notably, we have observed private credit lenders scaling up their capacity to provide financing that exceeds the traditional deal size, demonstrating their ability to compete for larger transactions effectively.

Speculative-Grade Issuers Slowing But Still Growing Overall

The broader universe of leveraged finance issuers demonstrated resilience once again in 2024, navigating economic uncertainties and elevated interest rates. Our dataset, which includes about 1,000 speculative-grade corporate entities in the U.S. and Canada and spans both public and private companies, shows that median EBITDA continued to grow, albeit at a slower rate of 0.4% in the 12 months ended Sept. 30, 2024. This marks a slowdown from the 0.7% growth reported in the 12-month period ending the previous quarter. Overall, 52% of issuers achieved EBITDA growth during this period.

However, this EBITDA gain was mostly driven by top-line revenue increases, as profit margins slipped slightly over the same period on a median basis, with 54% of issuers reporting lower margins. Smaller-scale issuers in particular faced challenges, experiencing both EBITDA contraction and margin erosion. Performance was also markedly different across industries, with margins in the technology sector expanding, while most other sectors contracted. It remains to be seen if this quarter's results will signal a longer-term trend.

Some margin pressures appear here to stay, such as in the auto industry. Automakers are grappling with growing pressure to reduce prices amid fierce competition and price-sensitive consumers, challenging margin expansion. Additionally, outside of auto, some companies are pinched between receding demand and moderating but still sticky input cost inflation. This is particularly concerning when higher costs are structural rather than seasonal, such as labor expenses in the transportation sector driven by tight labor markets and wage agreements ratified last year. At the same time, the potential erosion of household purchasing power could weigh on demand for goods and services across the board.

Industry Trends We Are Seeing

Restaurants and retail

EBITDA growth continues to face pressure as input and labor costs limit margin expansion. Furthermore, consumers (especially lower-income households) are deferring discretionary spending while continuing to trade down due to the high prices, elevated interest rates, and reduced savings. Despite these pressures, issuers sustained free cash flow generation thanks to debt repricing and refinancing during the year and tighter inventory management.

Capital goods

EBITDA growth continued to benefit from backlogs from multiyear investment decisions made by customers in 2022 and 2023. Even though the sector is sensitive to interest rates, customers take longer to reorient their capital expenditure (capex) budgets; as such, the interest rate peaks in 2023 and 2024 could impair customer demand with a lag (in 2025 or 2026).

Consumer products

Median EBITDA growth is slowing down due to depleted pandemic-era excess savings, especially for lower-income consumers, as well as a transition toward experiences from products. Despite this, median free operating cash flow (FOCF) to debt has improved over the past several quarters, supported by deleveraging, reduced capital intensity, and leaner inventory levels as supply chains normalize.

First-Lien New-Issue Recovery Unaffected By Restructured Debt, PIK Features

We examined quarterly trends in our recovery expectations for first-lien new issues, measured by average recovery point estimates (see chart 6). Starting in 2024, we excluded new issuance arising from restructuring debt exchanges to minimize reporting bias. For instance, we may only rate specific portions of exchanged first-lien loans, such as first-out and second-out tranches, and including only these senior tranches would inflate overall recovery expectations.

Conversely, including junior tranches, such as third-out or fourth-out--often so subordinated that they are effectively unsecured--would overly depress recovery. When excluded (as shown by the dashed line), the average recovery rose slightly by 1%-3% depending on the quarter, driven by a decline in the bottom-tier recovery estimates. However, the difference is minimal at about 1% for most quarters.

Chart 6

While the average recovery estimate was unchanged at 64% in fourth-quarter 2024 from the previous quarter, the new-issue universe now contains a higher percentage of first-lien debt with PIK options. These PIK instruments are often issued by companies under financial strain that are seeking short-term flexibility. For example, U.S.-based P&L Development Holdings LLC (CCC+/Negative/--) issued new PIK toggle notes to exchange part of its existing senior secured notes due November 2025. The company's still-weak credit metrics post-exchange suggest its capital structure remains unsustainable.

In our recovery analysis, PIK features are expected to prolong a distressed company's operations, potentially leading to a greater deterioration in enterprise value. This effect is similar to the absence of financial maintenance covenants. Combined with the accumulation of liabilities on the PIK facility, this dynamic could reduce first-lien recovery prospects at default.

Appendix

Table 1a

Table 1b

Table 1c

Table 2a

Table 2b

Table 2c

Table 3a

Table 3b

Table 3c

Table 4a

Table 4b

Table 4c

Table 5a

Table 5b

Table 5c

Table 6a

Table 6b

Table 6c

Related Research

• U.S. Leveraged Finance Q3 2024: Sponsor-Backed Companies Experiencing Highlights And Lowlights, Oct. 30, 2024
• Documentation, Flexible Structuring Continue To Reign In Private Credit, Sept. 17, 2024
• U.S. Leveraged Finance Q2 2024: Credit Trends Generally Positive, But First-Lien Recovery Prospects Still Under Pressure, Aug. 7, 2024
• Recovering From COVID-19: Why The Timing Of Bankruptcy And Emergence Matters For Debt Recovery, Feb. 7, 2022