Long-term interest rates have been heralded as attractive to private debt investors, but industry experts say monetary policy tightening is the next big pressure on the sector.
The world’s major banks are facing renewed inflationary pressure, following energy pressures caused by the war in the Middle East, raising the prospect of interest rate hikes.
That’s the problem with private credit, where debt is often a floating rate – meaning that the cost of paying off loans for borrowers under most portfolios may remain high, while lenders are forced to distinguish between short-term fluctuations and deep credit stress.
It comes as the $2 trillion private sector is already facing continued bailout pressure from companies developing retail-focused businesses, fears of an AI-driven ‘SaaSpocalypse’ heavy software portfolios, and individual corporate strikes.
Anant Kumar, managing director, global investment strategist, head of US credit research and portfolio manager at Benefit Street Partners, said the current state of private lending was built on the assumption that interest rate hikes in 2022 and 2023 were a peak that would decline quickly.
“Three years later, borrowers are still paying high-quality coupons,” Kumar said. “In fact, the market is now increasing prices, not reducing them. No one wrote that down.”
Private credit stress
Annual US inflation, which excludes food and energy prices, eased to 2.9% year-on-year in May, its highest rate since September 2025, and is expected to remain at that level when the June figure is released on Tuesday, according to consensus forecasts.
The latest minutes of a meeting of the Federal Reserve’s rate-setting Federal Open Market Committee under new chairman Kevin Warsh showed that officials were split on the rate path, with the dot grid pointing toward a single rate hike this year.
Kumar said higher average prices are helpful in the short term because yields are rising. But if rates stay high for too long, many small borrowers could be squeezed by the cost of paying interest.
“If rates go up from here, most premium companies won’t survive on their current capital structures. That doesn’t mean businesses are dying. It means restructuring,” he told CNBC via email.
Pressure on borrowers is already being felt in the form of maturity extensions, pay-in-kind (PIK) interest, sponsor checks and covenant releases – “usually that way”, says Kumar.
“Amendment one is fine – that’s a private liability that works as designed. But the fourth amendment in the same name is not a bridge to reinstatement, it’s a reversal,” he explained.
Sunaina Sinha Haldea, global head of private equity advisory at Raymond James, said higher rates don’t break private debt equally – but they accidentally remove the cap.
“The issue is not the loan of weak funds per person. The issue is the increase in the floating rate for businesses that were registered for a different rate system,” he said. “PIK, concession relief and maturity extensions can be useful tools when they buy time for real recovery. They become dangerous when they are used to maintain limited grades and delay the recognition of losses.”
PIK agreements are the most watched indicator of private pressure. These arrangements – which allow borrowers to defer interest payments by adding them to the loan’s principal, usually at a fee – can often indicate liquidity pressures and an increased risk of default.
“It’s one of the most watched numbers in the market,” Kumar said, citing Lincoln International data showing that more than 10% of direct loans now have a PIK component, up from 7% by late 2022.
“The pre-negotiated PIK of a growing company is fine. A cash-out loan converted to a mid-life PIK is telling… We treat a rising PIK as a smoke alarm but it’s not a reason to hit the panic button.”
Lenders are very selective
Looking ahead, higher default rates are likely to create a more selective environment for private debt, said Nicole Reid, research analyst, private market solutions at Aberdeen Investments.
“The impact on borrowers is increasingly mixed, with stronger businesses continuing to perform well while weaker credits face greater pressure to repay,” Reid said. “Defensive, non-cyclical sectors with good exposure to cash flows remain in a better position to absorb the long-term high-quality position.”
As the stress becomes more apparent – in the form of extensions, PIK agreements and other debt management measures that provide immediate cash flow relief – Reid said there is increasing scrutiny of sectors where the ratio and rating have been extended during the low rate. This is especially true in parts of the software market, where Reid said lenders have responded with wider spreads, stricter underwriting standards and an increased focus on strengthening cash flow.
Kumar added that the most vulnerable companies are those that pay fixed fees, have small margins, little cushion and limited ability to achieve long-term high prices.
The pressure is most acute on companies with weak pricing power, where operating costs and financial costs are rising but revenues are failing to keep pace. Real estate borrowers are more sensitive to the rate, while consumer businesses exposed to lower-income customers face more pressure, Kumar said.
“That crosses sectors… It’s a real case by case basis. You have to document the margins, the pricing power, the coverage.”
Kumar said size alone is not a reliable guide; larger companies may have better margins but tend to command more power, and are therefore more price sensitive. Smaller companies, in contrast, can be smarter.
“Complex communication. I can write a company, not a size bracket,” he added.
“This is a stress test, not a problem. A long lead separates the managers who wrote down the bad debt from the managers who wrote down the refinancing that never came. The next 18 months is a story about dispersion among lenders, not losses across the asset class.”
