As of 2022, the Federal Reserve has committed to raising interest rates to combat 7% inflation in the US, possibly by as much as 50 basis points which would drive up borrowing costs materially.
This means that interest payments on existing senior debt will rise since they are typically floating rates based on a spread off LIBOR. Interest payments on existing junior debt are usually at a fixed rate so they will not change. However, seeing as senior debt is usually the majority of the debt financing, this will have a material impact on the cash flows of portfolio companies, and companies that are running tight on cash flows may have to reduce expenses so they do not breach covenants.
This will also affect investment strategy. More expensive debt will affect PE firms that rely on aggressive leverage to win competitive auctions. They will have to take out less debt in order to meet covenants given the higher interest rates. This may be beneficial for PE firms that are more conservative as they will no longer be outbid as much by more PE firms that rely on aggressive debt financing. PE firms will likely be slightly more risk averse as they cannot acquire companies with more volatile cash flows given the materially higher cost of debt. Companies with recurring cash flows and high stability may become more popular as a result, while growth companies may be less appealing. Companies that thrived on cheap debt, such as those tied to the real estate and auto industry, may be less appealing as well as they lose customers who previously relied on generous credit terms.