As we highlighted last week, the zero-rate period post-GFC allowed private equity firms to buy companies with higher leverage and sell them at higher multiples. For the largest direct lenders, this included mega software businesses with increasingly borrower-friendly financing terms.

Reality returned in 2022 as SOFR soared from zero to 5%. Financing costs became headwinds, borrower leverage shrunk, and the upward march of purchase price multiples halted. Public credit markets shut down. Private markets remained open, but with M&A slowing, competition among upper-market lenders surged, resulting in 60% portfolio overlap (see Chart of the Week).

The core middle market is relationship driven. Sponsors and lenders are long-term holders so successful outcomes require alignment of interests. A solid partnership of trust is more valuable than squeezing the last turn of pricing or leverage. Sectors and borrowers must prove resilience through cycles because, unlike large caps, you can’t easily sell an “overweight” position.