WhiteHorse Capital executives Stuart Aronson (CEO) and Pankaj Gupta (President) provided a detailed 2025 lending outlook during a recent Middle Market Growth podcast, building on their accurate 2024 predictions of limited Fed rate cuts, persistent inflation, and aggressive lender behavior. Their analysis reveals several key trends:
Market Dynamics and M&A Activity
M&A acceleration
Expected 20% increase in deal flow due to lower SOFR rates (~4.3% currently), private equity pressure to return capital to LPs, and improved CEO optimism about economic conditions.
Valuation polarization
- Premium multiples (low-to-high teens EBITDA) for high-growth companies
- Discounted multiples (6.5-7.5x EBITDA) for cyclical/complex businesses as sellers adjust expectations
Credit Risk Landscape
Default concerns
Approximately $1.5B+ of 2020-2021 vintage loans may require restructuring due to:
- Overly optimistic EBITDA adjustments in underwriting
- Limited interest rate relief (only 50-75bp cuts projected)
- Consumer sector vulnerabilities
Structural risks
- Liability management transactions threatening recovery rates in upper-middle market deals
- 40-60% loss severity on defaults in covenant-lite structures
Underwriting Trends
Middle market divergence
Emerging risks
New lenders using aggressive tactics including:
- Excessive PIK toggle usage
- Overleveraged cyclical company financings
- "Banker-adjusted" EBITDA metrics detached from operational cash flows
Regulatory and Macro Considerations
Inflation watch
New administration policies (tariffs, labor restrictions, tax cuts) could limit Fed's ability to cut rates below 3.5-4% range.
Portfolio strategy shifts
WhiteHorse increased non-sponsored lending exposure to counter sponsor-driven market froth.
While projecting generally stable portfolio performance, executives cautioned that loss rates could exceed historical norms (80-100bps) if economic conditions deteriorate, particularly in deals with weak covenant protections.
What's Really Happening in Middle Market Lending
The EBITDA Games Are Getting Dangerous
We're beyond the usual add-backs now; we're witnessing businesses with negative EBITDA being presented as "adjusted EBITDA positive." This isn't merely aggressive—it's pure fantasy.
The Market Split Is Real
The divide between upper and lower middle market is wider than ever:
- Upper market: It's the wild west. "Diligence light" is becoming the norm. Newer players are skipping basic due diligence steps that used to be mandatory.
- Lower market: Still some sanity here. Traditional underwriting still matters, though competition is heating up.
New Players Are Changing the Game
New credit funds doing extreme things to secure deals.
- Stretching LTVs beyond reason
- Accepting PIK interest when cash flow clearly can't support the debt
- Taking sponsor projections at face value without verification
Regional Dynamics Matter More Than Ever
- Southeast: Seeing aggressive competition from new entrants
- Midwest: More traditional approach, better pricing power
- Coast markets: Covenant-lite becoming standard even for smaller deals
Portfolio Company Warning Signs
- More companies quietly seeking amendments
- Increase in sponsor-level support needed
- Rising number of "temporary" EBITDA adjustments becoming permanent
What This Means for Lenders
Practical Steps to Take Now
- Double down on real due diligence - don't get pressured into "diligence light"
- Watch your portfolio companies' actual cash flow, not adjusted EBITDA
- Be ready for more restructurings from 2020-2021 vintage deals
- Build relationships in the lower middle market where some sanity still exists
Where to Find Value
- Non-sponsored deals still offer better risk-adjusted returns
- Regional markets outside major centers
- Industries with actual hard assets (not just "adjusted" EBITDA)
Bottom Line
The market's hot, but it's also getting dangerous. Smart lenders need to:
- Stick to their underwriting standards
- Be ready to walk away from bad deals
- Focus on segments where traditional lending still matters
- Build war chests for the inevitable correction
Looking Ahead
In 2025, success will belong to those who uphold discipline amidst the chaos, while others recklessly pursue deals at any cost.
Our Opinion
We featured this story because WhiteHorse executives provide an honest view on lending market dynamics. Aronson highlights questionable EBITDA adjustments and loose underwriting standards. Their insights on the non-sponsored market's rigorous standards contrast with the "diligence light" trend in the upper middle market.
Pankaj's analysis of covenant erosion is detailed, emphasizing the issue of "covenant wide" deals. Stuart's comment on new lenders compromising credit quality in the lower middle market is spot-on.
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