Oil spike piles pressure on private credit borrowers as defaults rise

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.

“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.

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…