Key Takeaways
- • Fitch Ratings put the U.S. private credit default rate at a record 6.1% in the 12 months through July, and the oil spike is adding pressure on already-stressed borrowers.
- • Markets priced a near-70% chance of a Fed rate increase at the Sept. 15-16 meeting, per the CME FedWatch Tool, with inflation at 3.4% (CPI) above the 2% target.
- • Floating-rate direct lending loans, priced over SOFR, mean a Fed hike feeds quickly into borrower interest expense, while lenders get a short-term yield boost that can be eroded by credit losses.
- • Benefit Street Partners' Anant Kumar argues energy-driven inflation, not rates alone, is the bigger risk to leveraged borrowers, who face squeezed EBITDA and higher coupons simultaneously.
- • PIMCO and Nomura analysts say much of the adjustment has already occurred and that a broader economic slowdown, not a specific yield move, is the key threat.
Summary
Soaring energy costs are adding a new pressure point for private credit borrowers already carrying higher interest costs and a steep refinancing wall, according to private market specialists cited by CNBC. On Friday morning, U.S. West Texas Intermediate futures traded at $99.02 a barrel, down 3.4%, while Brent crude stood at $103.64, down 3.7%, following a sharp rise on Thursday amid escalating U.S.-Iran hostilities.
Oil's rise has fueled speculation of a Federal Reserve rate hike at its Sept. 15-16 meeting, as inflation remains above the central bank's 2% target. CME FedWatch data showed markets pricing a near-70% chance of a U.S. rate increase this month. Direct lending loans are typically floating-rate and priced over the Secured Overnight Financing Rate (SOFR), so a hike would generally raise borrowers' interest expense as benchmarks reset. The 10-year Treasury yield rose more than 11 basis points to 4.954% on Thursday.
Borrower stress is already visible. Fitch Ratings reported that the U.S. private credit default rate reached a record 6.1% in the 12 months through July. Highly leveraged companies trying to refinance debt raised during the 2020-2021 ultra-low-rate period are most exposed. Sunaina Sinha Haldea, global head of private capital advisory at Raymond James, said the refinancing wall is unlikely to arrive as a single event, but as a rolling process in which stronger borrowers refinance normally while stressed credits undergo amendments, extensions, equity injections and restructurings. She noted that borrowers with 2-3x interest coverage can absorb higher rates that would be unsustainable for a business near 1x coverage.
Anant Kumar of Benefit Street Partners said inflation, rather than rates per se, poses the biggest risk, as input costs and wages squeeze EBITDA while floating-rate coupons rise. Kumar noted that lenders get a short-term boost to portfolio yield from hikes, but that gain could be partly offset by higher credit losses among marginal borrowers.
Other market participants took a more measured view. Lotfi Karoui, multi-asset credit strategist at PIMCO, said the bigger risk is a combination of restrictive policy and weaker growth, and that much of the adjustment to higher borrowing costs has already occurred, with newer loans written under tighter underwriting and many vulnerable companies having extended maturities or secured lender support. Matthew Pallai, chief investment officer for private credit at Nomura Asset Management, said yields would need to rise another 50 to 100-plus basis points for lower-quality credits before the move affected market outcomes, adding that many borrowers and lenders had expected rates to fall after peaking in 2023-24.
Oil's rise has fueled speculation of a Federal Reserve rate hike at its Sept. 15-16 meeting, as inflation remains above the central bank's 2% target. CME FedWatch data showed markets pricing a near-70% chance of a U.S. rate increase this month. Direct lending loans are typically floating-rate and priced over the Secured Overnight Financing Rate (SOFR), so a hike would generally raise borrowers' interest expense as benchmarks reset. The 10-year Treasury yield rose more than 11 basis points to 4.954% on Thursday.
Borrower stress is already visible. Fitch Ratings reported that the U.S. private credit default rate reached a record 6.1% in the 12 months through July. Highly leveraged companies trying to refinance debt raised during the 2020-2021 ultra-low-rate period are most exposed. Sunaina Sinha Haldea, global head of private capital advisory at Raymond James, said the refinancing wall is unlikely to arrive as a single event, but as a rolling process in which stronger borrowers refinance normally while stressed credits undergo amendments, extensions, equity injections and restructurings. She noted that borrowers with 2-3x interest coverage can absorb higher rates that would be unsustainable for a business near 1x coverage.
Anant Kumar of Benefit Street Partners said inflation, rather than rates per se, poses the biggest risk, as input costs and wages squeeze EBITDA while floating-rate coupons rise. Kumar noted that lenders get a short-term boost to portfolio yield from hikes, but that gain could be partly offset by higher credit losses among marginal borrowers.
Other market participants took a more measured view. Lotfi Karoui, multi-asset credit strategist at PIMCO, said the bigger risk is a combination of restrictive policy and weaker growth, and that much of the adjustment to higher borrowing costs has already occurred, with newer loans written under tighter underwriting and many vulnerable companies having extended maturities or secured lender support. Matthew Pallai, chief investment officer for private credit at Nomura Asset Management, said yields would need to rise another 50 to 100-plus basis points for lower-quality credits before the move affected market outcomes, adding that many borrowers and lenders had expected rates to fall after peaking in 2023-24.
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