Getting Paid to Wait: Spread Endures in the Lower Middle Market

The illiquidity premium in private credit is migrating from the upper end of the market to the core and lower middle market, where fragmentation limits competition and preserves lender pricing power.

• Direct lending spreads fell from a peak of 716 basis points in March 2023 to 596 basis points at year-end 2024 and 544 basis points at year-end 2025.
• By early 2026, upper-market direct lending spreads were roughly 500–525 basis points, with about 85% of new-issue LBO spreads below SOFR+550 in the first quarter.
• The reopening of the BSL market reduced spreads from 450–475 basis points in 2022 to 325–350 basis points at the start of 2026; 2025 refinancing flows were nearly balanced, with approximately $37 billion moving from BSL into direct lending and $34 billion in the opposite direction.
• The U.S. middle market contains approximately 200,000 companies, while privately held middle-market companies outnumber privately held large-market companies by roughly 25 to 1, creating a fragmented borrower base that requires materially more origination and monitoring work.
• Covenant-lite structures increased from 4% to 21% of direct lending deals in 2025, but the deterioration was concentrated in larger transactions, while maintenance covenants remained prevalent in core and lower middle-market loans.

Takeaway: Investors should not assume that private credit’s historical premium has vanished, but should focus on managers with the infrastructure to source and monitor smaller borrowers, while recognizing that the upper market has already experienced substantial spread compression.