While long-term interest rates were once highlighted as an attractive yield factor for private credit investors, financial industry experts say tighter monetary policy is becoming the next big stress point for the sector.
Central banks around the world are facing new inflationary pressures due to energy strains caused by wars in the Middle East, raising the possibility of further interest rate hikes.
This is a problem for private credit, where debt typically has variable interest rates. This means that while lenders will need to distinguish between temporary flexibility and severe credit stress, debt servicing costs for underlying borrowers in many portfolios are likely to remain high.
This comes as the $2 trillion private sector is already battling continued reimbursement pressure on retail-focused business development companies, concerns that software-heavy portfolios will be upended by AI-driven SaaSpocalypse, and individual company failures.
Ananth Kumar, managing director and global investment strategist, head of U.S. credit research and portfolio manager at Benefit Street Partners, said the current private credit lending environment is built on the assumption that interest rate spikes will peak in 2022 and 2023 and then fall quickly.
“Even after three years, borrowers are still paying near-peak coupons,” Kumar said. “In fact, the market is now pricing in rate hikes, not rate cuts. No one was willing to buy that.”
Private credit pressure points
Consensus forecasts show that U.S. core annual inflation, which excludes food and energy prices, rose to 2.9% year-over-year in May, the highest level since September 2025, and is expected to remain near that level when June numbers are released on Tuesday.
The latest minutes of the Federal Reserve’s interest rate-setting Federal Open Market Committee, under new Chairman Kevin Warsh, show that officials are divided over the direction of interest rates, with the dot-plot grid leaning toward one rate hike this year.
Kumar said an increase in base interest rates usually helps in the short term as yields rise. However, if interest rates remain high for an extended period of time, more marginal borrowers may be squeezed by interest repayment costs.
“If interest rates rise from here, many leveraged companies won’t be able to survive with their current capital structures. That doesn’t mean they’re going to disappear. It means restructuring,” he told CNBC in an email.
Pressure on borrowers is already manifesting itself in the form of maturity extensions, payment-in-kind (PIK) interest, sponsor checks and contractual clause relief, “usually in that order,” Kumar said.
“One amendment is fine. It’s just private credit working as designed. But the fourth amendment with the same name is not a bridge to recovery, it’s a postponement,” he explained.
Sunaina Sinha Haldea, global head of private capital advisory at Raymond James, said rising interest rates are not uniformly destroying private credit, but the margin for error is gone.
“The problem is not floating rate loans per se. The problem is floating rate leverage on business that is underwritten under different interest rate regimes,” he said. “PIK, covenant relief, and maturity extensions can be useful tools when buying time for a full recovery. Risk increases when used to preserve par and delay loss recognition.”
PIK agreements are receiving increasing attention as an indicator of private credit stress. These arrangements, which allow borrowers to pay cash interest on top of the loan principal (usually for a fee), can often represent liquidity stress and increased default risk.
“This is one of the hottest numbers in the market,” Kumar said, citing data from Lincoln International showing that more than 10% of direct loans now have a PIK component, up from 7% in late 2022.
“It’s fine that PIK was negotiated upfront for growing companies. The fact that cash-paying loans were converted to PIK mid-life is a deciding factor…We treat rising PIK as a fire alarm, but not a reason to press the panic button.”
Lenders become more selective
Nicole Reid, research analyst for private market solutions at Aberdeen Investments, said rising interest rates are likely to lead to a more selective environment for private credit.
“The impact on borrowers is becoming increasingly diverse. Healthy companies continue to do well, while companies with weaker credit are facing greater refinancing pressure,” Reid said. “Defensive non-economic sectors with favorable cash flow prospects are well-positioned to absorb a prolonged high interest rate environment.”
As stress becomes more pronounced, in the form of extensions, PIK agreements and other debt management measures that provide short-term cash flow relief, there is increased scrutiny of sectors that have become overleveraged and overvalued during the low interest rate era, Reid said. This is especially true in parts of the software market, where Reed said lenders are responding by widening spreads, tightening underwriting standards and increasing cash flow resilience.
Kumar added that the companies most at risk are those that get by on fixed-fee coverage because of thin profit margins, little cushion and limited ability to absorb interest rate increases over time.
The squeeze is most acute for companies with weak pricing power, which sees operating and financing costs rise but profits cannot keep up. Kumar added that real estate-related borrowers are particularly sensitive to interest rates, and consumer businesses exposed to lower-income customers are facing additional pressure.
“It’s cross-sector… It’s really case-by-case. You have to take on margins, pricing power, coverage.”
Kumar said size alone is not a reliable guide. Large companies may have better profit margins, but they often have greater leverage, which makes them more sensitive to interest rates. In contrast, smaller companies can be more agile.
“This is a complex interaction. I would take on the company, not the size,” he added.
“This is a pressure test, not a crisis. Rising long-term rates will separate managers who took on deals on the downside from those who took on refinances that never materialized. The next 18 months will be a story about dispersion across lenders, not losses across asset classes.”
