This report does not constitute a rating action.

A new era of uncertainty will test resilience of direct lending portfolios. S&P Global Ratings anticipates the immediate impact of the Trump administration’s tariff policy will be contained for direct lending portfolios due to their predominantly domestic focus and emphasis on services. However, second-order effects—such as sustained inflation, weakened consumer spending, reduced corporate investment, recessionary pressures, and overall market unpredictability--could have significant consequences (see "Global Macro Update: Seismic Shift In U.S. Trade Policy Will Slow World Growth", published May 1, 2025). Since the implementation of April 2 tariffs, coupled with broader policy shifts under the Trump administration, heightened volatility has disrupted financial markets as investors respond to increased geopolitical, trade-related, and economic uncertainties. While most tariffs announced April 2 are currently on a 90-day pause, a universal baseline import tariff of 10% remains in place, with many imported Chinese goods facing an additional 145% levy. We expect tariff policies will continue to evolve (see "Credit Conditions North America Special Update: Tariff Turmoil", published April 17, 2025).

Secondary Impact Will Present Challenges

The direct impact may be contained, but ripple effects will present challenges for the middle market. In isolation, we expect tariffs will have a limited primary impact on the credit-estimated companies in our rated middle-market collateralized loan obligations (CLOs) because the portfolio mostly consists of U.S.-based firms with relatively low reliance on imported goods, little exposure to discretionary consumer products, and modest cross-border sales exposure (noting that we also provide scores for numerous Canadian companies). However, recognizing that tariffs along with the possibility of exemptions and unpredictable retaliatory measures, represent just one aspect of a broader narrative is critical. Additionally, the Trump administration’s immigration policies (particularly the impact on industries reliant on immigrant labor such as agriculture, construction, and hospitality) and initiatives aimed at reducing federal spending through the Department of Government Efficiency (DOGE), could also pose implications for this market.

S&P Global Ratings’ substantial credit estimate universe is a conduit to understanding the direct lending market’s dynamics, while providing an indication of credit quality for unrated entities whose loans are held in middle-market CLOs. Our CE portfolio is highly concentrated in the software, health care services, and business/professional services segments. Combined, they represent nearly 40% of our universe and are generally less reliant on physical shipments of goods across borders. Nonetheless, second-order forces, such as a potential slowdown in consumer spending and corporate expenditure, could still hurt software or business services, and as price-takers, some health care services companies may face limitations in passing on higher costs of medical supplies and devices. The remainder of the CE portfolio features lighter but meaningful allocations in sectors where the direct effects of tariffs may be more pronounced, such as construction and engineering, health care equipment, machinery, chemicals, and distributors.

In aggregate, the top 20 sectors in our CE universe constitute about 80% of the portfolio (see table 1).

Table 1

Top CE sectors
These sectors constitute 80% of the CE portfolio.
Sector	Sector allocation of total credit estimates (%)	Median EBITDA margin (%)
Software	12.5	22.6
Health care providers and services	11.2	13.9
Commercial services and supplies	7.2	15.3
Professional services	7.1	18.4
Construction and engineering	4.5	12.0
IT services	4.2	15.3
Diversified consumer services	4.0	22.0
Media	3.7	20.2
Hotels, restaurants, and leisure	2.8	20.3
Health care technology	2.7	24.3
Health care equipment and supplies	2.6	18.8
Machinery	2.6	16.1
Chemicals	2.3	17.6
Food products	2.3	12.7
Trading companies and distributors	2.0	11.4
Distributors	1.8	13.0
Insurance	1.7	24.2
Aerospace and defense	1.6	17.2
Electronic equipment, instruments, and components	1.3	16.3
Containers and packaging	1.2	14.9
CE--Credit estimate. Source: S&P Global Ratings.

In addition to being highly leveraged, many credit-estimated entities are also smaller or medium enterprises, which could be disadvantaged in terms of negotiating power and cost pass-through ability. That may present issues for low-margin businesses and those in highly competitive markets. Thus, for the ones with direct exposure to tariffs, their ability to mitigate or bypass the consequences and navigate other policy-related headwinds will depend on individual strategic positioning.

Broader economic trends will influence the cost of funding for the middle-market, where loans are predominantly secured floating-rate instruments tied to benchmark rates set by the Federal Reserve. Therefore, if tariff-driven inflation spurs a higher-for-longer interest rate scenario, borrowers whose cash flows are already strained by elevated interest charges (especially the 15% of the CE portfolio obligors in the ‘ccc’ score category that are particularly vulnerable to nonpayment) would experience exacerbated difficulties. The transition to a structurally higher cost of funding has been wearing on ‘ccc’ credits; and our interest rate sensitivity analysis indicated there may be insufficient near-term relief for debt-laden companies (see "Systemic Risk: Private Credit’s Characteristics Can Both Exacerbate And Mitigate Challenges Amid Market Evolution", published Feb. 18, 2025). Nonetheless, this uncertainty can also create opportunities for direct lenders to gain market share if broadly syndicated loan (BSL) financing is inaccessible for riskier speculative-grade borrowers.

We continue to assess credit risk at the borrower level even though some sectors may be hit harder than others. Although certain industries may face disproportionate impacts in the current operating environment, we continue to assess credit risk at the borrower level. Each company varies in its ability to navigate stresses, providing value in bottom-up portfolio analysis. The CE downgrade to upgrade ratio during the first quarter of 2025 was just above one to one, though we expect downgrades will rise gradually as the potential impact of tariffs and other factors becomes more evident in the second half of the year (see "Private Credit And Middle-Market CLO Quarterly: Unknown Unknowns", published April 25, 2025).

As long as merger and acquisition (M&A) activity and sponsor exits remain muted, we also anticipate an uptick in selective defaults (SDs) as troubled borrowers seek relief through extensions on nearing debt maturities and potentially add or stretch payment-in-kind (PIK) terms if costs of debt stay elevated, reversing a trend of SDs declining over the past year. With investor risk appetite waning, spreads have widened, and amendment terms could become more favorable for lenders in the near term. For already distressed companies, default horizons may accelerate as liquidity constraints tighten and sponsors become more selective with additional support.

Direct Impact

At least 10% of our overall credit estimates portfolio may be vulnerable to direct ramifications from tariffs. After reviewing internal and external credit documentation across our approximate portfolio of more than 3,100 CEs, we believe at least 335 companies could be directly exposed to tariffs through significant cross-border sales or international supply chain dependencies. Anecdotally, we have heard several asset managers sizing similar percentages of their direct lending portfolios that could be disproportionately vulnerable to tariffs, with estimates ranging from mid-single to low-double digit percentages.

Of the tariff-sensitive firms we identified, more than two thirds were scored at 'b-' or higher--confirming tangible downside risk for this subset. However, our analysis will be done on a credit-by-credit basis and the outcomes among these borrowers will vary based on their ability to adapt to rapidly evolving trade conditions. The sectors we observed with the highest count of CEs with potential direct exposure s are listed below:(see chart 1).

Chart 1

Our analysis of the tariff-susceptible entities revealed numerous companies with cross-border sales between the U.S. and Canada, as well as larger firms with global revenue streams. For companies reliant on supply networks outside the U.S., manufacturing facilities were often located in Mexico and/or Canada--unsurprising given the locales’ lower labor costs, prior trade agreements, and nearshoring following supply disruptions during the COVID-19 pandemic.

Of the 335 entities with elevated tariff exposure, at least one-fifth appeared to source a substantial share of their inputs specifically from China, which is a critical consideration due to ongoing trade tensions between Beijing and the U.S. This figure is likely understated, though it provides context as China is a key supplier for many providers of aftermarket auto parts, original equipment manufacturing (OEM) parts for other industrials, and various retailers or distributors of medical equipment and discretionary consumer goods. Based on our review, some of the companies had already been transitioning all or part of their supply chains to the Americas or other parts of Asia, like Cambodia and Vietnam, over the past few years (similar to borrowers in the syndicated loan and high yield markets).

Federal cost-cutting should have a minimal impact on middle-market firms. Only around 70 companies in the credit estimate portfolio--amounting to roughly 2% of our coverage universe, and the vast majority ‘b-‘ companies--face an elevated likelihood of significant exposure to federal-level government contracts that DOGE could potentially target for future termination or modification (see "Economic Research: U.S. Economic Outlook Update: Higher Tariffs And Policy Uncertainty To Weaken Growth", published May 1, 2025). In this analysis, we excluded companies with meaningful revenue exposure to state and local-level governments, despite some states--such as Florida and Oklahoma--beginning to implement their own localized versions of DOGE.

Companies with meaningful federal-level exposures were primarily clustered in the software, IT services, professional services, aerospace and defense, and construction and engineering sectors. The exposed services or products mostly encompassed systems engineering, cybersecurity tools, data analysis and document management software, IT and operations consulting, and materials and devices used by federal agencies such as the Department of Health & Human Services, Department of Defense, NASA, and the U.S. intelligence community.

Stress Test

A separate scenario analysis targeting CEs currently scored at 'b-' suggests 14% could be at risk of downgrades in a moderate stress scenario. To gauge the vulnerability of our CE portfolio, we conducted a stress test on the 'b-' score segment-- which represents around 77% of our CE universe. This sector-agnostic stress test incorporates varying degrees of simultaneous top-line and margin declines to assess the impact on key borrower credit metrics, such as cash interest coverage and liquidity, which we’ve found to be key determinants for downgrades in the past.

“At risk” borrowers range from 14% of the ‘b-’ subset in a moderate stress scenario to 21% in a severe stress case (see chart 2).While not a direct parallel, these stress scenarios could pose risks that, in certain respects, might rival or exceed those seen during the COVID-19 pandemic.

Chart 2

Given our portfolio concentration at the 'b-' level, these stress scenarios and the corresponding number of downgrades could raise our 'ccc' category distribution from 15% to a range around 25%-31%. However, this does not account for possible offsets from selective upgrades or new CEs scored at 'b-' or above – which served as a counterbalance to many of our downgrades to the 'ccc' category in 2024, with the 'ccc' distribution remaining relatively flat at the mid-teens percent year over year. For comparison, the 'ccc' camp constituted approximately 22% of a smaller CE portfolio at the peak of the pandemic.

Nevertheless, an increase in downgrades, which would likely occur over a prolonged period, could impact S&P-rated middle-market CLOs--whose reinvesting average 'ccc' category exposures currently stand at 13.8%.

Conditions For Private Credit Can Change As The Market Evolves

Although the primary effects of the tariffs may be manageable for most private credit, second-order repercussions on demand and overall market volatility could pose significant challenges for middle-market borrowers. Uncertainty lingers in the current market landscape and conditions are subject to change. S&P Global Ratings economists project the Fed will cut interest rates 50 basis points this year. If economic conditions emerge resiliently (with reduced interest rates and an uptick in M&A), some of the burdens on corporate borrowers may ease. We’ll continue to evaluate credit risk at the borrower level, as each company's capacity to withstand stress differs.

Related Research

• Economic Research: Global Macro Update: Seismic Shift In U.S. Trade Policy Will Slow World Growth, May 1, 2025
• Economic Research: U.S. Economic Outlook Update: Higher Tariffs And Policy Uncertainty To Weaken Growth, May 1, 2025
• Private Credit And Middle-Market CLO Quarterly: Unknown Unknowns, April 25, 2025
• Credit Conditions North America Special Update: Tariff Turmoil, April 17, 2025
• Systemic Risk: Private Credit’s Characteristics Can Both Exacerbate And Mitigate Challenges Amid Market Evolution, Feb. 18, 2025

Primary Contact:	Denis Rudnev, New York 1-212-438-0858; denis.rudnev@spglobal.com
Secondary Contacts:	Scott B Tan, CFA, New York 1-212-438-4162; scott.tan@spglobal.com
	Shannan R Murphy, Boston 1-617-530-8337; shannan.murphy@spglobal.com
Research Contributors:	Ashita A Chandane, CRISIL Global Analytical Center, an S&P Global Ratings affiliate, Pune ;
	Bhagyashree Vyas, CRISIL Global Analytical Center, an S&P Global Ratings affiliate, Pune ;
Contributors:	Evangelos Savaides, New York 1-212-438-2251; evangelos.savaides@spglobal.com
	Michael S Neiss, Toronto 1-416-507-2572; michael.neiss@spglobal.com
	Beau K Keppler, Toronto 1-4165072506; beau.keppler@spglobal.com
	Adrianna Gonzales, New York ; adrianna.gonzales@spglobal.com
	Anh Tran, Toronto ; anh.tran@spglobal.com
	Zachary Wolfe herman, Toronto ; zachary.w@spglobal.com