Private credit faces a rate squeeze as inflation pressure returns

Private credit is facing a fresh test as renewed inflation pressure raises the odds that interest rates stay elevated or move higher. For retail investors who own business development companies or private-credit funds, the key issue is whether borrowers can keep paying interest without pushing losses into the future.

Private credit refers to loans made outside public bond markets, often by asset managers to companies owned by private equity sponsors. Many of those loans carry floating rates, meaning the borrower’s interest cost rises or falls with benchmark rates rather than staying fixed.

That structure helped lenders earn higher income when central banks lifted rates in 2022 and 2023. Now, industry professionals told CNBC, the same structure is putting pressure on companies that were financed on the expectation that rates would come down sooner.

Anant Kumar, managing director, global investment strategist, head of U.S. credit research and portfolio manager at Benefit Street Partners, told CNBC that borrowers are still paying interest costs near recent highs three years after the initial rate surge. He said markets are now pricing in possible rate increases rather than cuts, adding: “Nobody underwrote for that.”

The pressure is building as global central banks deal with renewed inflation concerns tied to an energy squeeze from the Middle East war, according to CNBC. Core annual U.S. inflation, which strips out food and energy, rose to 2.9% in May, its highest level since September 2025, and consensus forecasts cited by CNBC expect it to remain near that level in the June report.

Federal Reserve minutes from the latest Federal Open Market Committee meeting under Chair Kevin Warsh showed officials split on where rates should go next, with the Fed’s dot plot pointing toward one rate hike this year, CNBC reported. The dot plot is the Fed’s chart showing policymakers’ individual expectations for future interest rates.

Kumar said higher base rates can help private credit returns at first because lenders collect more income. Over time, though, companies with heavy debt loads can struggle to cover interest payments. If rates rise further, he told CNBC, many leveraged companies may need restructurings rather than being able to keep their current debt setups.

Signs of stress are already appearing, according to Kumar, through maturity extensions, payment-in-kind interest, sponsor support and covenant relief. Covenants are loan rules meant to protect lenders, and relief means lenders agree to loosen those rules. Kumar said one amendment can be normal in private credit, while repeated amendments on the same borrower may amount to delaying recognition of deeper problems.

Payment-in-kind, or PIK, interest is getting special attention. PIK lets a borrower avoid paying some cash interest now by adding that amount to the loan balance, usually at a cost. Kumar cited Lincoln International data showing more than 10% of direct lending loans now include a PIK component, up from 7% in late 2022.

Sunaina Sinha Haldea, global head of private capital advisory at Raymond James, told CNBC that floating-rate loans are not the problem by themselves. She said the risk comes from floating-rate debt on companies that were assessed under a different rate environment. PIK, covenant relief and maturity extensions can help when a recovery is realistic, she said, but can become risky if they preserve loan values and delay loss recognition.

Nicole Reid, a research analyst in private markets solutions at Aberdeen Investments, told CNBC the impact is becoming more uneven. Stronger companies are still performing, while weaker borrowers face more refinancing pressure. She said defensive, non-cyclical sectors with clearer cash flow are better placed to handle rates staying high.

Kumar said the most vulnerable borrowers tend to have thin margins, limited cushion and weak pricing power, meaning they cannot easily raise prices to offset higher costs. He pointed to real-estate-linked borrowers as especially rate-sensitive and said consumer companies exposed to lower-income customers face added pressure.

The private credit market is also dealing with redemption pressure in retail-focused business development companies, concerns about artificial intelligence affecting software-heavy portfolios and several company-specific failures, according to CNBC. Kumar described the current period as a pressure test rather than a broad crisis, with results likely to vary sharply by lender and borrower.

This story draws on original reporting from CNBC.