Soaring energy costs are creating a fresh pressure point for private credit borrowers already facing higher interest costs and a steep refinancing wall, private market specialists say.
U.S. West Texas Intermediate futures were trading at $99.02 a barrel at 6:35 a.m. E.T. Friday, down 3.4%, while Brent crude, the global price benchmark, was at $103.64, a 3.7% dip. Oil’s rise comes amid growing speculation over a Federal Reserve interest rate hike at its Sept. 15-16 meeting as inflation remains above its 2% target.
A rise in borrowing costs is particularly relevant for private credit, where direct lending loans are typically floating-rate debt and are priced at a spread over the Secured Overnight Financing Rate, or SOFR — a benchmark for overnight Treasury-backed borrowing.
For borrowers with floating-rate loans, a Fed hike would generally raise interest expense as benchmark rates reset.
As oil prices moved decisively higher Thursday amid escalating U.S.-Iran hostilities, Anant Kumar, global investment strategist at Benefit Street Partners, suggested energy-driven inflation is a bigger risk to private credit borrowers than interest rate rises alone.
Brent crude.
“The other piece people are missing is why the Fed is contemplating a hike in the first place — this isn’t a growth-driven tightening; it’s a response to 3.4% [CPI] inflation with an energy shock behind it,” Kumar told CNBC via email.
“For a leveraged borrower that’s a double hit, with input costs and wages squeezing the EBITDA on one side while the floating-rate coupon rises on the other,” he said. “Inflation, not rates per se, is the biggest risk to private credit, and a hike for these reasons is exactly that risk showing up.”
Borrower stress is already weighing on private markets. Fitch Ratings’ U.S. private credit default rate hit a record 6.1% in the 12 months through July.
A further Fed hike would add to the burden for highly leveraged companies, particularly those trying to refinance loans raised during the ultra-low-rate boom of 2020 and 2021.
Refinancing challenges
The CME FedWatch Tool showed markets are now pricing in a near-70% chance of a U.S. rate increase this month. But investors expect the refinancing challenge to unfold gradually, rather than trigger a single market-wide impact.
“The refinancing wall is unlikely to arrive as one dramatic event,” said Sunaina Sinha Haldea, global head of private capital advisory at Raymond James.
“It is more likely to be a rolling process in which stronger borrowers refinance normally, while stressed credits are dealt with through amendments, extensions, equity injections and restructurings. Rising defaults and non-accruals suggest that process is already underway.”
The most exposed borrowers are those entering the higher-rate environment with heavy debt loads and little cushion to cover interest costs, Haldea said. “A borrower with strong earnings growth and 2–3x interest coverage can absorb rates that would be unsustainable for a highly-leveraged business already close to 1x coverage,” she added.
Kumar said a 25-basis-point Fed move would feed quickly into private credit portfolios because of their floating-rate structure. While lenders initially benefit from higher income, boosting investment returns, that advantage can be eroded if weaker companies struggle to service their debt.
“There’s a short-term boost to portfolio yield from any hikes, but you could give that up partially in the form of higher credit losses, if some of the more marginal borrowers can’t make their interest payments in the higher rate environment,” Kumar added.
U.S. 10-year Treasurys.
U.S. Treasury yields moved higher on Thursday, with the benchmark 10-year note yield jumping more than 11 basis points to 4.954%, as fears over persistent inflation remain.
Still, investors said the key threat for private credit borrowers remains a broader deterioration in the economy, rather than any immediate move in Treasury yields or policy rates alone.
“The bigger risk is not a specific Treasury yield, but a combination of restrictive policy and weaker growth that undermines cash flows and debt-servicing capacity,” said Lotfi Karoui, multi-asset credit strategist at PIMCO.
Karoui added that much of the adjustment to higher borrowing costs has already taken place in private credit, with newer loans written under tighter underwriting standards and many vulnerable companies having extended maturities or secured lender support.
“Absent a recession, the payment shock ahead is likely much smaller than the one they have already navigated,” Karoui said.
Matthew Pallai, chief investment officer for private credit at Nomura Asset Management, said yields would need to rise much further to reshape pricing or create a widespread default problem.
“For real concern to be raised to a point that it affects market outcomes would require at least another 50 to 100-plus basis points move for lower quality credits,” Pallai said. “It is difficult to understand the rate views at underwriting of all transactions, but it is fair to say that a large portion of the market participants – both borrowers and lenders – have over the last two years held the view that rates would be coming down after peaking in 2023-24.”
Haldea said: “The recent move in government bond yields is a reminder that private credit borrowers cannot simply rely on falling base rates to solve the refinancing equation. The focus is increasingly shifting from waiting for cheaper money to whether businesses can support today’s all-in cost of debt through earnings growth, deleveraging or additional equity.”
