Private credit quality likely to deteriorate in 2026, Morningstar DBRS Outlook shows
We expect worsening credit profiles for both high- and low-quality borrowers.
Editor’s note: This article originally appeared on Morningstar’s US site and has been amended for an Australian audience. The insights in this piece are globally focused, but we have determined that the findings are still relevant for Australian audiences.
Key takeaways
- Private credit quality looks likely to deteriorate in 2026.
- Despite stronger sales growth, EBITDA margins remain stressed for many borrowers.
- Increasing debt balances signal a pickup in acquisition activity.
The Morningstar DBRS outlook for private borrower credit quality trends remains negative as we head into 2026. Fundamental operating results show an increase in borrowers experiencing margin compression from a year ago. Leverage has also increased materially for many borrowers, spurred by lower base rates and an uptick in acquisition activity among higher-rated borrowers. Meanwhile, the weakest borrowers in our portfolio will remain pressured by weak top-line performance, shrinking margins, and the erosion of already-constrained liquid resources.
We view more restrictive and rapidly changing global trade policy as a key threat in 2026. As the full impact of tariffs and other policy changes during 2025 flow through results, we may see an acceleration in the margin compression trends we are already observing.
Other key highlights:
- The trend in credit metrics is weaker at both ends of the ratings spectrum.
- Increasing debt balances signal a pickup in acquisition activity.
- Private borrowers remain proactive in managing loan maturities.
The weakest borrowers continue to face weak top-line performance, shrinking margins, and erosion of already-constrained liquid resources. In our September 2025 commentary highlighting private borrower reliance on capital support, we reported that borrowers operating under covenant relief expanded from 9% to 10% of active borrowers over the past year. We also noted that roughly 40% of these borrowers face significantly weakened liquidity positions relative to capital needs over the next year. We expect this group to continue to lead downgrades and defaults next year.
The distribution of EBITDA margin remains skewed toward a net contraction, with 61% of borrowers indicating weaker margins over the past year. The largest proportion of borrowers (35%) experienced margin contraction between zero and negative 250 basis points.
A deeper look into financial results for borrowers active for more than one year reveals more broad-based weakness. Approximately 12% now have cash flow below zero, while 13% have IC ratios less than 1 time (x). For comparison, 7%-8% of comparable borrowers a year ago had cash flow below zero or an IC ratio below 1x.
Much of the expansion in these proportions appears to be in the B rating range. In the CCC and lower range, we note only modest expansion in the higher risk proportions: 55.6% of borrowers with cash flow below zero compared to 54% a year ago and 57% with IC ratios below 1x compared with 55.6% a year ago.
Despite an acceleration in debt growth among European borrowers, we still view credit quality among borrowers in the region as better positioned relative to U.S. borrowers. Compared with Europe, the U.S. group continues to face a greater degree of margin compression, mitigating the positive effect from recent base interest rate reductions.
Meanwhile, European borrower results reflect relatively stable cash flow metrics and improved interest coverage ratios, indicating a greater degree of cash flow flexibility relative to the United States.
