The world of private credit is facing a critical juncture as rising interest rates put borrowers under increasing pressure. This sector, once seen as a haven for investors seeking attractive yields, is now navigating a challenging landscape.
The Impact of Higher Rates
The assumption that interest rates would quickly decline after the spike in 2022 and 2023 has proven to be a costly miscalculation. Borrowers are still paying near-peak coupons, and the market is now anticipating further hikes. As Anant Kumar, a managing director at Benefit Street Partners, puts it, "Nobody underwrote for that."
Pressure Points
Core annual U.S. inflation, excluding food and energy prices, has surged to its highest level since 2025, and the Federal Reserve's rate-setting committee is divided on the direction of rates. Higher base rates can provide short-term relief, but prolonged elevated rates can squeeze marginal borrowers.
According to Kumar, "If rates go up from here, many levered companies won't survive in their current capital structures." This doesn't necessarily mean the end for these businesses, but it could lead to restructurings.
Signs of Stress
The pressure on borrowers is evident through maturity extensions, payment-in-kind (PIK) interest, sponsor checks, and covenant relief. Sunaina Sinha Haldea, global head of private capital advisory at Raymond James, notes that higher rates are not affecting private credit uniformly, but they are reducing the margin for error.
PIK agreements, which allow borrowers to defer cash interest payments, are a closely watched indicator of stress. These arrangements can signal liquidity issues and rising default risk. Lincoln International data shows that over 10% of direct lending loans now have a PIK component, up from 7% in late 2022.
A More Selective Environment
Looking ahead, the elevated rates backdrop is likely to drive a more selective approach in private credit lending. Nicole Reid, a research analyst at Aberdeen Investments, explains that the impact on borrowers is becoming increasingly differentiated. Stronger businesses continue to perform well, while weaker credits face greater refinancing pressure.
Defensive, non-cyclical sectors with good cash flow visibility are better positioned to weather the higher-for-longer rate environment. As stress becomes more visible, there is growing scrutiny of sectors where leverage and valuations became stretched during the low-rate era, particularly in parts of the software market.
Companies at Risk
The companies most at risk are those with weak pricing power, where operating and financing costs rise but revenue fails to keep pace. Real estate-linked borrowers and consumer businesses exposed to lower-income customers are particularly vulnerable.
Kumar emphasizes the importance of underwriting the margins, pricing power, and coverage on a case-by-case basis. Size is not a reliable indicator, as larger companies may have better margins but carry more leverage, making them more rates-sensitive.
A Test of Resilience
This period is a pressure test, not a crisis, according to Kumar. It will separate the managers who underwrote a downside case from those who assumed a refinancing that never materialized. The next 18 months will tell a story of dispersion between lenders, not losses across the asset class.
In my opinion, this is a critical moment for the private credit sector, and the ability to navigate these challenges will define the resilience and adaptability of the industry.
