Based on a portfolio of around 50 European companies rated by Scope, the credit risk profile of direct lending borrowers is high: the average rating is in the B category. The borrower universe represents the typical sector split, with the strongest exposures to business and consumer services, TMT, healthcare and financial services.

“The average credit profile is a natural consequence of the borrower universe: middle-market companies typically operating in market niches with highly leveraged balance sheets and ambitious debt-funded growth plans,” said Sebastian Zank, Co-Head of Corporate Ratings. “Credit ratings are further constrained by lack of transparency inherent in this market around financial reporting, strategy and corporate governance.”

Direct lending certainly has challenges, not just poor transparency, but also limited headroom for deleveraging and potentially challenging refinancing rounds. “Nevertheless, we remain constructive about the growth of direct lending and associated fundraising in Europe. Neither the challenging current sentiment, selected defaults, corporate restructurings nor the return of banks to syndicated lending are enough to jeopardise our positive medium-term outlook for direct lending,” Zank said.

Our outlook is driven by a number of positive drivers: strong structural demand for non-bank financing, which provides an appealing risk-return for a widening investor base; an increasing focus on smaller middle-market corporates; a high proportion of sponsor-driven activity; a stabilisation of credit profiles amid interest-rate tapering; and continued economic growth, which is helping companies in the typical sectors.

“For the development of the market in 2026, we believe pressure on credit quality will somewhat ease, given lower rates and their direct impact on companies that primarily work with variable-rate debt. We see the decline in benchmark rates since 2024 lifting average interest cover from below 2x in 2023/2024 to 2x and above from this year,” Zank noted. This is further supported by forecast economic growth higher than the average growth rate between 2023 and 2025 in the euro area and the UK.

We believe leverage will remain high amid ambitious M&A strategies which, although moderating, continue to be the dominant reason for limited headroom for deleveraging. Our company sample indicates that average leverage (debt/EBITDA) will stay above 6.0x, keeping credit ratings at a low level. Locking in elevated leverage increases refinancing complexity and credit risk in a higher rate environment. A refinancing surge will test the resilience of borrowers.

“For the credits covered by Scope, refinancing risk represents the most significant vulnerability, although, continued economic growth and easing concerns about rebounding interest rates and inflation should be supportive of the credit profiles of direct lending borrowers,” Zank said.

Download the full report here.