Higher-for-longer interest rates were once heralded as an attractive yield driver for private credit investors, but industry professionals say tighter monetary policy is becoming the sector’s next major stress point.
Global central banks are grappling with renewed inflation pressures, following the energy squeeze caused by the Middle East war, which is raising the prospect of further interest rate hikes.
That’s a problem for private credit, where debt is typically floating-rate — meaning debt-servicing costs for underlying borrowers in many portfolios are likely to stay higher, while lenders are forced to distinguish between temporary flexibility and deeper credit stress.
It comes as the $2 trillion private sector is already contending with ongoing redemption pressures in retail-focused business development companies, fears of an AI-driven ‘SaaSpocalypse’ upending software-heavy portfolios, and individual corporate blow-ups.
Anant Kumar, managing director, global investment strategist, head of U.S. credit research and portfolio manager at Benefit Street Partners, said the current private credit lending landscape was built on the assumption that the interest rates spike of 2022 and 2023 was a peak that would quickly decline.
“Three years later, borrowers are still paying near-peak coupons,” Kumar said. “In fact, the market is now pricing hikes, not cuts. Nobody underwrote for that.”
Private credit pressure points
Core annual U.S. inflation, which excludes food and energy prices, jumped to 2.9% year-on-year in May, its highest level since September 2025, and is expected to remain around that level when June’s figure is released Tuesday, according to consensus forecasts.
The latest minutes of the Federal Reserve’s rate-setting Federal Open Market Committee meeting under new chairman Kevin Warsh showed officials were split over the direction of rates, with the dot-plot grid tilting towards one rate hike this year.
Kumar said higher base rates typically help in the short term because yields rise. But if rates stay high for an extended period, more marginal borrowers can be squeezed by interest servicing costs.
“If rates go up from here, many levered companies won’t survive in their current capital structures. That doesn’t mean the businesses die. It means restructurings,” he told CNBC via email.
Pressure on borrowers is already showing up in the form of maturity extensions, payment-in-kind (PIK) interest, sponsor checks and covenant relief — “usually in that order”, Kumar said.
“One amendment is fine — that’s just private credit working as designed. But the fourth amendment on the same name is not a bridge to recovery, it’s deferral,” he explained.
Sunaina Sinha Haldea, global head of private capital advisory at Raymond James, said higher rates are not breaking private credit uniformly — but they are removing the margin for error.
“The issue is not floating-rate loans per se. The issue is floating-rate leverage on businesses that were underwritten for a different rate regime,” she said. “PIK, covenant relief and maturity extensions can be useful tools when they buy time for a real recovery. They become risky when they are used to preserve par marks and delay loss recognition.”
PIK agreements are an increasingly closely watched indicator of private credit stress. These arrangements — which allow borrowers to defer cash interest payments by adding them to the loan principal, typically for a charge — can often signal liquidity stress and rising default risk.
“It’s one of the most-watched numbers in the market,” Kumar said, citing Lincoln International data showing that more than 10% of direct lending loans now have a PIK component, up from 7% in late 2022.
“PIK negotiated upfront for a growth company is fine. A cash-pay loan flipped to PIK mid-life is the tell… We treat rising PIK as a smoke alarm but not a reason to push the panic button.”
Lenders become more selective
Looking ahead, the elevated rates backdrop is likely to drive a more selective environment for private credit, said Nicole Reid, research analyst, private markets solutions at Aberdeen Investments.
“The impact on borrowers is becoming increasingly differentiated, with stronger businesses continuing to perform well while weaker credits face greater refinancing pressure,” Reid said. “Defensive, non-cyclical sectors with good cash-flow visibility remain better positioned to absorb a higher-for-longer rate environment.”
As stress becomes more visible — in the form of extensions, PIK agreements and other liability-management measures that provide near-term cash-flow relief — Reid said there is growing scrutiny of sectors where leverage and valuations became stretched during the low-rate era. This is particularly true of parts of the software market, where Reid said lenders have responded with wider spreads, tighter underwriting standards and increased focus on cash-flow resilience.
Kumar added that the companies most at risk are those scraping by on fixed-charge coverage, with thin margins, little cushion and limited ability to absorb a prolonged period of elevated rates.
The squeeze is sharpest for companies with weak pricing power, where operating costs and financing costs rise but revenue fails to keep pace. Real-estate-linked borrowers are particularly rate-sensitive, while consumer businesses exposed to lower-income customers face added pressure, Kumar added.
“That cuts across sectors… It’s genuinely case-by-case. You have to underwrite the margins, the pricing power, the coverage.”
Kumar said size alone is not a reliable guide; larger companies may have better margins but often carry more leverage, and are therefore more rates-sensitive. Smaller companies, in contrast, can be more nimble.
“It’s a complex interplay. I’d underwrite the company, not the size bracket,” he added.
“This is a pressure test, not a crisis. Higher-for-longer separates managers who underwrote a downside case from managers who underwrote a refinancing that never came. The next 18 months is a story about dispersion between lenders, not losses across the asset class.”