The environment was quite constructive to start 2025, with significant deal flow carrying over from 2024 and expectations for improved business conditions. That momentum was paused with the unveiling of tariff policy in early April.
Expanding transaction activity, supported by the lower rate environment and clarity on economic and regulatory conditions, gave way to a new uncertainty and middle market direct lending deal flow slowed considerably. Sellers had been actively seeking transactions with expectations for somewhat higher enterprise values (EV), but buyers pulled back with the newfound uncertainty while sellers continued to hold out for their “right” price.
Throughout much of 2025, the clouds of policy uncertainty slowly cleared, which led to a notable resumption of U.S. middle market deal flow post Labor Day.
The transaction environment is now back to the favorable setting experienced at the beginning of 2025, and there is even more reason to believe that growth will continue.
We believe the improving and supportive market and economic backdrop, coupled with appealing credit structures, should create an environment ripe with attractive investment opportunities in 2026.
Improved economic clarity, easing Fed policy, and private equity sponsors’ eagerness to realize investment returns and deploy over $2 trillion in dry powder after years of slower activity, are driving strong momentum for increased transaction volumes in 2026.
As rates decline, lower and core middle market direct lending’s yield premium becomes even more valuable to investors, and coupled with strong covenants and disciplined underwriting, should deliver compelling risk-adjusted returns in 2026.
Middle market direct lending’s credit structures with meaningful covenants as well as committed and steady capital sources provide protection from BSL credit events and public market volatility.
*Drawdowns are reflective of quarter end index values.
Source: Bloomberg U.S. Corporate High Yield Bond Index, Cliffwater Direct Lending Index, S&P/LSTA Leverage Loan Index, SPX (S&P 500 Index) MSCI ACWI Index, Bloomberg U.S. Corporate Investment Grade Index, Bloomberg U.S. Aggregate ABS, and Infrastructure (Dow Jones Brookfield Global Index), 30 June 2025. Past performance is not a reliable indicator of future performance and should not be relied upon for an investment decision. Indices are unmanaged and do not take into account fees, expenses, and transaction costs and it is not possible to invest in an index.
Loan to value for middle market LBOs by EBITDA size (%)
Source: LSEG, 30 September 2025.
The improving and supportive market and economic backdrop, coupled with appealing credit structures, should create an environment ripe with attractive investment opportunities in 2026. And the discipline of the market continues to be intact with lower and core middle market direct lending transactions continuing to represent the credit structure and underwriting standard that has set middle market direct lending apart from the public high yield and BSL markets.
We are focused on alignment with clients and approach direct lending with an investor mindset, always seeking to achieve the strong value proposition that is available with lower and core middle market direct lending through both PE sponsor-backed and non-sponsored lending opportunities.
The path ahead in 2026 will likely take a few twists and turns along the way. At Principal Alternative Credit, we look forward to maintaining our disciplined process and delivering strong risk-adjusted returns.
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Risk considerations
Past performance is no guarantee of future results. Investing involves risk, include possible loss of principal invested. Investments in private debt, including leveraged loans, middle market loans, and mezzanine debt, are subject to various risk factors, including credit risk, liquidity risk and interest rate risk.
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Indices are unmanaged and do not take into account fees, expenses, and transaction costs and it is not possible to invest in an index.
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MM13781-02 | 01/2026 | 5074739-122027