The world of private credit is facing a critical juncture as the era of higher interest rates continues to squeeze borrowers. What was once seen as a boon for investors is now a growing concern, with industry experts highlighting the challenges posed by tighter monetary policies.
The Impact of Rising Rates
The global inflation landscape, exacerbated by the Middle East war, has forced central banks to consider further rate hikes. This is a significant issue for private credit, where floating-rate debt is prevalent, leading to higher debt-servicing costs for borrowers. The $2 trillion private sector is already navigating redemption pressures, fears of AI-driven disruptions, and individual corporate failures.
Anant Kumar, a managing director at Benefit Street Partners, highlights the assumption that interest rates would quickly decline after the spikes of 2022 and 2023. However, borrowers are still paying near-peak coupons, and the market is now anticipating hikes rather than cuts. This was not anticipated, and it poses a significant challenge.
Private Credit Pressure Points
Core annual U.S. inflation, excluding food and energy prices, has reached its highest level since 2025, and the Federal Reserve's minutes indicate a potential rate hike this year. Higher base rates can provide short-term benefits, but prolonged periods of high rates can squeeze marginal borrowers. As a result, lenders must distinguish between temporary flexibility and deeper credit stress.
Sunaina Sinha Haldea, global head of private capital advisory at Raymond James, emphasizes that higher rates are not affecting private credit uniformly. The issue lies in the floating-rate leverage on businesses that were underwritten for a different rate regime. PIK agreements, covenant relief, and maturity extensions can provide temporary relief, but they become risky when used to delay loss recognition.
A More Selective Environment
Nicole Reid, a research analyst at Aberdeen Investments, predicts a more selective private credit environment due to the elevated rates backdrop. The impact on borrowers is becoming differentiated, with stronger businesses performing well and weaker credits facing refinancing pressure. Defensive, non-cyclical sectors with good cash flow visibility are better positioned to absorb the higher-for-longer rate environment.
As stress becomes more visible, there is increased scrutiny of sectors where leverage and valuations became stretched during the low-rate era. This is particularly true for parts of the software market, where lenders are implementing wider spreads and tighter underwriting standards. The companies most at risk are those with weak pricing power, thin margins, and limited ability to absorb prolonged periods of elevated rates.
Underwriting the Company, Not the Size
Kumar emphasizes the importance of underwriting the company rather than relying on size as a guide. Larger companies may have better margins but often carry more leverage, making them more rates-sensitive. Smaller companies, on the other hand, can be more agile. It's a complex interplay that requires a case-by-case analysis, considering margins, pricing power, and coverage.
In conclusion, the next 18 months will be a story of dispersion between lenders rather than losses across the asset class. It's a pressure test that will separate the managers who underwrote a downside case from those who relied on a refinancing that never materialized. The private credit landscape is evolving, and the ability to adapt and underwrite for a range of scenarios will be crucial.
