Margin Compression Remains a Key Challenge for Private Borrowers

The performance of private middle-market issuers reviewed in the first half of the year points to an ongoing erosion of credit quality, but with an underlying divergence between higher- and lower-rated issuers. These trends are consistent with our 2024 private credit rating outlook, which predicted companies would continue to experience margin compression and deterioration in operating cash flow and interest coverage, driven by persistent cost inflation and reduced ability for many companies to pass through higher costs to customers. Our key observations include the following:

-- We continue to observe a broad deterioration in credit metrics across the portfolio, driven by factors including margin compression.
-- Mid-year results show fundamentals of higher-rated credits strengthening, while lower-rated credits continue to slide.
-- Weakness in interest coverage ratios has concentrated in the lower rating categories, as external pressures continue to erode cash flow and liquidity for more-vulnerable issuers.

"We expect existing negative momentum in top-line growth and ongoing margin compression to drive further downward migration in ratings over the next six to 12 months," said Michael Dimler, Senior Vice President, Private Credit Ratings. He adds: "We believe the erosion in the performance of middle-market issuers explains the increasing bifurcation in private rating actions, as many higher-rated issuers are showing incremental strength while performance among many weaker-rated issuers continues to slip."