Private credit
What is Private credit?
Private credit is debt financing negotiated outside broadly syndicated public markets, commonly through funds that originate or acquire loans to companies, assets, or projects.
A private-credit allocation should be evaluated against comparably risky public loans and bonds, not against government yields or cash. Reported spread must be adjusted for leverage, management and incentive fees, defaults, delayed recognition, and illiquidity. Investors should demand vintage-level loss and recovery data, identify amendments that avoid non-accrual classification, and test whether marks are independently challenged when borrower performance weakens.
What it includes
Strategies include direct lending, asset-based finance, mezzanine, specialty finance, real-estate debt, and distressed or opportunistic credit. Loans may be senior or subordinated, sponsored or non-sponsored, floating or fixed, and secured or unsecured. Structures, documentation, covenants, leverage, and borrower quality vary substantially, so private credit is not one homogeneous risk class.
Sources of return
Return can include base interest, credit spread, original-issue discount, fees, prepayment income, and equity warrants, less defaults, recoveries, expenses, leverage cost, and manager fees. Floating rates can raise income while also straining borrowers. Reported yield is not expected return unless probability, timing, recovery, and reinvestment are incorporated.
Example
A fund makes a five-year senior loan at a floating reference rate plus 6%, with a 2% upfront fee. If rates rise, coupon increases, but the borrower's coverage deteriorates and default probability rises. A quarterly model mark near par can conceal weakening economics until a restructuring or external transaction reveals value.
Due diligence
Assess manager sourcing, underwriting, covenants, collateral, sector expertise, workout capability, conflicts, leverage, valuation, and realized loss history. At loan level, review borrower cash flow, sponsor, debt stack, documentation, maturity, interest coverage, collateral control, and downside recovery. Separate gross asset yield from investor return after financing, fees, defaults, and idle cash.
Risks and practical checklist
Private credit faces default, illiquidity, valuation, leverage, covenant, concentration, refinancing, fraud, and recovery risk. Capital can be locked for years and distributions uncertain. Stress non-accruals, rate changes, collateral declines, and delayed exits. Verify independent administration and valuation, map unfunded commitments, and avoid interpreting smooth marks or high current yield as evidence of low volatility or safety.
Sources and further reading
- Investments in Private Capital: Equity and Debt, CFA Institute