A recent S&P Global Ratings report warns that these impacts could trigger a sharp rise in distress among middle-market companies. Even sectors once considered insulated are showing signs of weakness as macroeconomic conditions deteriorate.

The shift is already prompting a response in credit markets. Traditional banks are scaling back exposure to riskier segments while regulatory scrutiny is tightening. Some hedge funds have gone so far as to bet against private credit entirely, arguing that higher interest rates and economic stagnation will expose systemic flaws in a rapidly growing sector.

Arif Bhalwani, CEO of Third Eye Capital, views the current volatility as a turning point that will separate lenders who built their portfolios with discipline from those who simply chased high yields. He points out that private credit is now a bedrock of corporate finance, often stepping in where banks cannot or will not lend. While certain loan structures, including payment-in-kind (PIK) interest arrangements and stretched leverage profiles, are drawing scrutiny, these mechanisms are “a tool, not a ticking time bomb”, Bhalwani said in a recent social media post.

“When structured thoughtfully, (PIK) aligns capital efficiency with borrower cash preservation, and often signals a lender actively managing through cycles, not masking distress.”

The core challenge is not new: how to support businesses navigating temporary disruption without compounding their problems with inflexible capital. But the current moment is testing that premise in new ways. Many of the borrowers under stress today are not failing due to bad business models, but because they are caught in a tightening vice of input costs, uncertain demand, and limited access to new funding.

In this climate, the role of private credit is shifting from opportunistic to essential. Lenders with the experience and infrastructure to restructure deals are finding themselves in demand. The question is how many of them are equipped to manage that complexity.

The S&P report does not forecast widespread failure, but it notes that the sector is entering a phase where fundamentals will matter more than ever. Underwriting standards, deal structures, and lender behavior during the post-pandemic expansion are now under the microscope.

For firms like Third Eye Capital, which excel at bespoke lending strategies, the moment offers both risk and opportunity. Bhalwani has argued that private credit is not a monolith and should not be judged by the weakest performers. Still, the stakes are clear. If borrower distress continues to rise, the test will not be whether private credit can lend in theory, but whether it can adapt in practice.

Tariff risks are just one part of the equation. As global trade tensions escalate, the economic aftershocks will likely continue to filter down through supply chains, balance sheets, and investor portfolios. The resilience of private credit will depend not only on the quality of its assets but on the flexibility and judgment of those managing them.

In the months ahead, investors and regulators will be watching the asset class closely. The middle market’s period of stress could fundamentally reshape private credit. Whether it emerges more resilient or more fractured will depend on how well lenders handle the unfolding uncertainty. 

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