sport football: Underwriting Risk in a Tariff World

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Hey guys,

Harry here. We've got a piece diving into the tariffs landscape today.

But first I wanted to give a quick reminder re: HYH Premium - we're running HYH Premium 20% Off during the month of May. You can learn more here but HYH Premium is my library of Credit Recruiting and City Guide content. With prices across the economy likely on the rise with tariffs, I wanted to provide an opportunity to be a price giver rather than a price taker.

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Underwriting Risk in a Tariff World

Well - the world changed quite a bit since I first started writing this. Thank God it did too.

While risk mitigation is still front and center, we can talk about playing offense a bit too. If we get the deregulatory type of environment that a lot of people envisioned prior to the tariffs, there's reason to be excited about certain themes in 2H25.

While a ton of reciprocal tariffs on nations have been paused, the China tariffs and baseline of 10% tariffs have thrown a wrench into a lot of the planning of U.S. based companies. A lot of the Companies and Business Owners that were supposed to be helped by the administration and now looking down the barrel instead.

I've always thought this tariff noise can only go on for so long and has to be largely contained to 2Q. There are other fish to fry and tariffs can't flow into the 2026 midterm elections. Plus, this is a complete "on-and-off switch" dictated by President Trump. I concede that there will probably be overflow into 3Q, but I'll keep my guesstimates short-term in nature given the volatility this administration gives us.

Things are very subject to change. We've learned over the past 90 days that it's nearly impossible for businesses and consumers to make large decisions in uncertain environments.

With all the tariff uncertainty, I've been speaking with a lot of folks on how they're reacting. A lot of shops are doing complete portfolio reviews. This means checking under the couch cushions for anything they haven't been appreciating. Or pretty much re-underwriting everything. Following that, the individuals responsible for coverage present or write to investment committee defending the position and why this should be a hold, buy, or sell, and explaining where exactly the risks are in the business.

I think this has been pretty unreported and we'll eventually get a Bloomberg article out on how chaotic things are behind the scenes in the private markets.

Even with the pause, many of these supply-chain heavy deals are an immediate pencils down for a lot of investors. Instead of trying to underwrite something they can't effectively underwrite, some managers are electing to instead to invest in businesses that are more services based or don't have significant cost of materials volatility.

This whole thing was crazy in retrospect: While tariffs were always on the table, this wasn't all totally predictable. No one thought we'd be talking about 145%-245% tariffs. Or that we'd be so aggressive towards allies. But tariffs that were more aggressive than what was done in the first administration was very much vocalized. A lot of people figured that an administration that zoned in more on low corporate tax rates, rather than zoned in on incremental tariffs, would take that same approach again the 2nd time around. Instead, business friendly and deregulation related policies have not been the focal point quite so far.

Still, during January and February, I was actively saying "This deal looks bad because of 1) tariffs and the impact they're about to have or 2) secondary DOGE impacts." These were pretty obvious trends. Even with that, you still had a pretty hot market and some poor investing choices being made.

The severity of Liberation Day, as well as the confusion regarding where the numbers in the table were coming from, threw a "wtf!" curveball for investors and business leaders. We're going to have to revisit these reciprocal tariffs shortly, because Treasury Secretary Bessent has admitted that any country that doesn't agree to a deal with the U.S. will see those reciprocal tariff rates instituted again.

What's going down:

The pivot from 145% tariffs was massive, but investors and management teams remain on high alert. Not every Company has an easy switch. There was a massive pull forward in demand to get in front of tariffs. Products bought in advance can only hold off the inevitably higher prices for so long. A lot of guys are battening down the hatches and trying to weather the storm with their current inventory.

Main street hasn't necessarily seen the impact of all this yet, but once consumers see higher prices the tariff policy will become a lot less popular. Which is why I think the bulk of tariff escalation needs to be confined to 2Q.

With the highest tariff rates probably off the table, we can at least have some comfort on having to worry about broader layoffs. But that was certainly something management teams were thinking should passing on prices to the consumers not work.

From a High Yield Bond and Leveraged Loan perspective:

Some of the best deals come out of an un-thawing of the markets. This means when the market is "closed" and someone needs to go out with some higher spread to entice folks back into the market.

As things continue to unthaw, the following traits are crucial when evaluating opportunities:

Companies that pass on prices
Companies with vertical integration who has control of their supply chain and alternatives they can leverage. This may include have a focus on domestic production
Businesses that are asset-lite or more service oriented may be insulated
Non-discretionary spend that you cannot defer

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From a Private Credit perspective:

The last thing you want to do is buy more debt of a very illiquid name.

For obvious reasons, Private Credit and Private Equity is much more illiquid in terms of reducing exposure or exiting a name than the liquid credit markets are.

Private Credit and Private Equity is full of more off-the-cuff deal flow than the liquid credit markets, and you'll certainly see some deals that are taking forever to find equity and/or debt financing. A CIM or Lender Presentation might be going around, you'll take a look, see the tariff-related risk, and be like "ah okay that's why this deal is being marketed still". Maybe there's an opportunity where one man's trash is another man's treasure, but you should be cognizant of this when you're doing the work.

If you one-stop-shopped this then you're stuck holding a slug. If you were the agent on a unitranche transaction or were part of a lender group, there might be some liquidity to exit.

For the names most impacted by tariffs, the focus will shift to whether some of these names deserve a massive revolver draw, incremental debt, or an equity check.

Amendments are coming (but to a lesser degree than we originally thought): What differentiates this situation from covid is the fact that there's much more of an on-and-off switch that one person (our President) has. It still comps to a bit of what happened during covid. During covid, there were massive "covid" add-backs added to EBITDA that lenders allowed. Given that these impacts were 6-18 months long, and the long-term performance of the business was going to be fine, this was acceptable for a lot of folks.

From a Private Equity perspective:

Congrats, I hope this was in your downside case. Like it or not you need to manage this new reality.

COGS and Capex structures have been totally upended. I've had people let me know that some of the products they procure have risen exponentially. Firms that have been dramatically impacted are pulling back aggressively on spend. Growth Capex might as well be stopped immediately until a better sense of understanding of what is going on happens. This has lessened a bit given the cool-off in China tariffs, but folks are still on high alert.

People have also noted they are scouring for new sourcing and trying to figure out how to localize. This can be a big tailwind for some domestic based manufacturers or suppliers, but there's so many imported inputs that it's hard to avoid tariff pressures entirely.

There's been a massive pull forward of inventory. One respondent let me know that consumer discretionary companies with excess or overpriced inventory are going to be in for a world of pain. This makes sense - as tariffs rise, there's a lot of discretionary things I'd very much like to forgo.

But we haven't talked about the revenue side of the equation, where companies are going to have to force this onto the consumer in order to keep margins flat or not have FCF nosedive. It was noted by Bloomberg that the 10% tariff rate, excluding the Chinese impact, would require a retailer to do a 4.9% increase in price that is passed onto the consumer.

Thank god the highest rates got rolled off, because small businesses were getting decimated in the process. It's important to call this out, as the "Snip, Snap" nature of tariffs causes damage. In one instance, the founder of Dr. Ginger's Healthcare Products, an oral care company, said they ordered 5,000 bamboo lip gloss tubes that were shipped from China. While the order cost her $5,000, the tariff that she had to pay was $9,983 - which triples COGS! She had to take out a loan to adjust for this added expense.

Smaller manufacturers that are reliant on the spot market are much more exposed to the volatility here.

I'm a big supporter of small business, which is why I'm so impassioned about a lot of what I'm writing in this piece. As of now, we're assuming that the China tariff de-escalation is going to be permanent. But even a few weeks of these tariffs was far too destructive to maintain.

CUTS - a high-profile example:

The CUTS CEO drew fire for writing a plea to President Trump on tariffs. He acknowledged he voted for Trump, but called out how the rise of tariffs from 25% to 145% will destroy CUTS as well as thousands of other eCommerce companies. Borrelli called for a delay that allows companies like his 9-12 months to react.

Steven Borrelli @stevenborrelli

Dear President Trump, @realDonaldTrump

I am the founder of a clothing brand called CUTS. We are a bootstrapped business that has been around for eight years and are a true example of living the American dream. We've built this business to millions of dollars in revenue over the

4:12 PM • Apr 15, 2025

7.73K Likes 879 Retweets

2.67K Replies

Ik a decent amount of NYC people that wear CUTS that seem to like the brand, but a lot of X users said he "is getting what he deserves".

I don't think it's really in good taste to say who and who should not go out of business because of these massive tariff shocks - the actual free market should define that. If you're rooting for thousands of small businesses to get destroyed you probably need to look in the mirror. And I don't think anyone actually predicted 145% rates plus insane reciprocal tariffs. People get highly revisionary in terms of the "I told you so dynamics". Not to mention the fact that it's impossible to effectively source and produce a ton of stuff in America. I'm pretty pro businesses not getting wrecked due to arbitrary federal policies that don't give small businesses relief.

Other notable industries impacted by the tariffs:

A snapshot into the toy industry: In a Wall Street Rollup piece a month ago, we wrote about the how the toy industry is the poster child for these bad tariff policies.

No Toymakers to the King: Toymakers have been devastated by tariffs imposed on China, with the maker of Bratz dolls having 50%+ exposure there, and the rest of the products made in nations like Vietnam, Indonesia, and India. The toy industry has 80% exposure to China, with the giant toy maker Mattel having ~20% exposure. In fact, one Princeton, NJ based toy store spent a whopping $400k before tariffs to load up on inventory. Mattel even admits that their exposure is significantly lower than the rest of the toy industry - so while they can weather the storm, we're once again unfairly treating flat-footed small businesses.

Will there be Fireworks for the Fourth of July? It's a mixed answer. 95% of the Fireworks imported in the U.S. come from China. Back when the 145% tariffs were in effect, at least 10 small fireworks in the area folded because they couldn't afford steep price hikes (per a local newspaper from Northwest Indiana). Shipping was at a total standstill. But according to one fireworks expert I trust, the fireworks industry is over-supplied, so many shops may be okay for 2025. Here's a look at other industries more impacted by China:

Via Apollo

This is a boom for some domestic manufacturers though: There's some U.S. manufacturers with an increase in demand due to being an alternative to 145% tariffed products - but even those guys are dealing with rising input costs. Some of the beneficiaries include a manufacturing tools business, a rubber gaskets and plastic pails provider, and Whirlpool, who assembles 80% of its U.S. appliances domestically.

But it's been a really tough draw of the cards for a lot of folks.

There is simply no plan B for several SMBs, LMM, and Middle Market firms. I cross my fingers, but it's also my investment thesis, that we've had peak pain, and that any further pain will be felt around the edges, as opposed to a massive jump to 145%.

At least finality around other countries is coming soon:

On the bright side, we're approaching finality on peak tariff rates with a lot of countries. However, this is probably because a bunch of countries got nowhere with tariffs. Bessent has noted that finalized announcements are coming, and there may be some regional deals though, especially in Central America and Africa.

I think we've learned this administration's pain tolerance is very low and very short - and it sounds like things change on the dime quickly. I truly believe we're going to reach an end-game sooner rather than later.

To conclude - I believe the bulk of tariff related conversations will happen in 2Q, and the administration can't really have this leak too far into 3Q. That's why the focus in Congress is turning towards corporate tax cuts, SALT, removing taxes on tips, and other deregulatory policies.

Regardless, we're probably going to need legislative reform around what constitutes national security related tariffs, because it still blows my mind that we almost let one guy cause a self-inflicted recession.

Whether you're staying defensive, or starting to go on offense, I wish you the best of luck in your underwriting.

Until next time.

Harry

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