US LNG exports surge but will buyers in China turn up?
Investing.com -- The recent shifts in U.S. trade policy and the potential for prolonged tariffs could significantly impact middle market credit quality, according to Morningstar DBRS.
While the agency does not expect an immediate effect on its rated private credit portfolio, a prolonged increase in tariffs “may drive greater divergence between strong and weak middle market borrowers,” analysts led by Candice Gao said.
Currently, a 10% tariff on Chinese imports has been in effect since February 1, 2025, and additional tariffs on imports from Canada, Mexico, and Europe remain a possibility for the coming months.
"Growing uncertainty surrounding U.S. trade policy has increased the specter of disruption to the major economies," analysts stated. If these proposed measures are fully implemented, they could push the effective U.S. tariff rate significantly higher, affecting credit conditions for middle market borrowers.
Companies operating with high financial leverage and limited pricing power may be particularly vulnerable.
"Tariffs on imported goods would increase the cost of raw materials and components, posing challenges for lower-rated companies," analysts said in a report. Manufacturing and consumer products firms that struggle to pass rising costs to customers may face deteriorating cash flows and weakened credit metrics.
The report also highlights potential supply chain disruptions, with tariffed producers prioritizing shipments to non-tariffed countries. This could lead to higher working capital demands and unfinished orders sitting in inventory, further straining financially weaker borrowers.
“We expect to see worsening credit conditions for already lower-rated borrowers that have a weaker ability to pass-through costs, and for those with significant manufacturing operations with a heavy reliance on importing raw materials and products,” the note adds.
Conversely, Morningstar DBRS expects a less noticeable impact on middle market borrowers, particularly those rated B (high) and above, and primarily service-oriented issuers.
"Companies that focus on local manufacturing or local materials sourcing are less exposed to tariffs on imported goods," the agency said. Additionally, firms using cost-plus contracts, which allow them to pass cost increases onto customers, are better positioned to maintain margins.
Lastly, companies that can swiftly transition to local suppliers will also face fewer negative effects, analysts note, as their ability to adapt supply chains helps mitigate tariff-related disruptions.
Higher interest rates add to the challenges for weaker middle market issuers, which are more vulnerable due to their reliance on floating rate debt. While some have received support from sponsors and lenders, a prolonged period of elevated rates could strain liquidity further.
Meanwhile, corporate confidence remains subdued, with little expectation of increased M&A activity in 2025. Economic uncertainty is likely to keep companies focused on refinancing rather than major transactions.
Looking ahead, Morningstar DBRS maintains a stable outlook but warns that prolonged tariff pressures could deepen the divide between strong and weak borrowers, especially if margin compression accelerates.