“The scope of our rating portfolio gives us a unique perspective on how credit is evolving among privately held sponsor-backed companies,” said Micael Dimler, senior vice president, private corporate credit, at Morningstar DBRS, during a webinar on 2 April 2026.
Morningstar DBRS rates 500 private middle-market borrowers across North America and Europe. In addition, it provides credit estimates on a further 1200 borrowers. It focuses primarily on the lower end of the middle market, targeting companies with around $250m in revenue and approximately $50m in Ebitda (or US dollar equivalents), with an average rating in the B category.
Europe’s earlier credit resilience is beginning to fade
A primary takeaway of Dimler’s presentation is the divergence between Europe and the US. While Europe entered 2026 appearing somewhat healthier than North America, with a more robust rating mix and fewer distressed names, concerns are emerging. European borrowers initially benefited from a faster decline in interest rates compared to their US counterparts, which provided earlier relief on borrowing costs.
However, debt levels in Europe are now rising at a faster rate than in the US. While European firms have shown improved revenue growth, their margins have not kept pace, leading to a mild but noticeable compression.
Migration into CCC territory signals mounting credit stress
Dimler highlighted a significant drift in credit quality across the global portfolio. There has been a clear movement of ratings from the “B and below” categories into “CCC” and lower buckets, which are classified as "distressed” (chart 1).
Chart 1: Portfolio Mix by Rating Category Source Morningstar DBRS
The “rating downgrade-to-upgrade ratio” serves as a key barometer of market sentiment. While downgrades outpaced upgrades by roughly two to one in 2025, the pace of deterioration has eased slightly in early 2026. Dimler attributed it to a lack of new downgrades rather than an increase in upgrades, suggesting that underlying credit pressure persists.
Rising leverage strains private credit
Approximately 10% of Morningstar DBRS-rated portfolio now sits in a “critical zone” (see chart 2), meaning these companies have negative cash flow or interest coverage below 1x, leaving Ebitda insufficient to cover annual interest expenses. This group has increased steadily over the past two years, reflecting the strain on credit metrics globally.
Chart 2: Proportion of borrowers with metrics below “critical zone” Source Morningstar DBRS
Interestingly, credit performance is increasingly bifurcated: stronger, higher-rated borrowers are increasing gearing to fund acquisitions, whereas weaker borrowers are seeing leverage rise because of margin compression.
The environment for private credit remains challenging due to these soft margins and rising leverage. Dimler warns that if these trends continue, private equity sponsors may face an ongoing difficult exit environment characterised by lower valuation multiples.
Already, nearly 10% of active borrowers have sought covenant relief, with many requiring capital supports such as equity injections, sponsor guarantees, or “PIK” (payment-in-kind) interest options. An additional 18% of the portfolio is currently viewed as vulnerable and may require similar support in the coming quarters.
Borrowers from 2019–21 most exposed
Dimler noted that 17 borrowers defaulted over the last year. He suggested the market appears to be roughly midway through the current credit cycle. The impact of potential interest rate hikes depends heavily on when a loan was underwritten.
The 2019 to 2021 vintages are the most vulnerable, as they were underwritten before the current high-rate environment emerged. While newer loans have more cushion built into their metrics, further rate increases would likely pressure sector stability further.
AI disruption tests software moats
Regarding the technology sector, software accounts for roughly 10% of their rated portfolio. These borrowers are concentrated in the “B and below” categories. While software firms benefit from sticky customer relationships and high margins, they are not immune to margin compression and creeping leverage as debt has risen faster than Ebitda.
In the near term, the threat of AI is considered manageable for companies with solid “moats.” However, long-term success will depend on how effectively these firms integrate disruptive technologies into their products.
Overall, the data points to a market entering a more fragile phase, where resilience will depend on margin recovery and disciplined leverage management.
