(Bloomberg) -- Lower-rated private credit borrowers are expected to “remain stuck in the mud” next year, as they stare down declining sales, weakened margins and high borrowing costs, according to a Morningstar report.

Defaults and downgrades are expected to increase in 2025, albeit at a more gradual pace compared to this year, Morningstar said in its Thursday report. In 2024, about 1.4% of the more than 400 middle-market borrowers in Europe and North America rated by Morningstar saw downgrades, outpacing upgrades by about 2.5 times. 

While vulnerable firms may continue to face pressure next year, higher-rated borrowers are more likely to “benefit in the near-term from lower interest rates and moderately supportive economic conditions,” Morningstar said in its note. The gap between stronger and weaker borrowers is expected to be more pronounced next year, the ratings firm added. 

Weaker companies, generally rated CCC or lower, saw revenues decrease by 11.2% on average, despite a 20% rise in 2023, according to the report. On the other hand, higher-rated middle market firms grew their revenue by 6.1% on average. 

Though many anticipate mergers and acquisitions to pick up next year, Morningstar expects most middle-market firms to stay focused on refinancing transactions for the time being. Almost 40% of all requests into Morningstar to discontinue middle-market ratings through mid-November of this year were tied to non-M&A-related refinancings away from existing lenders.

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