Private Credit, Explained

Private credit is the fastest-growing alternative asset class of the last decade, and most people still can't define it. The one-sentence version: instead of a bank lending money to a company, an investment fund does — and you can own a piece of the fund.

Why it exists

After 2008, regulators made it more expensive for banks to hold risky corporate loans. Banks retreated from mid-market lending, and a gap opened: profitable companies that were too small for the bond market and no longer wanted by the banks still needed to borrow. Funds stepped into that gap. They raised capital from institutions and wealthy individuals, lent it directly to companies, and collected the interest the banks walked away from.

That's the whole model. You are the bank now — you hold the loan, you collect the coupon, you eat the loss if the borrower defaults.

The borrowers are usually mid-sized companies, very often ones owned by private equity firms. A PE firm buys a business, needs debt to finance the deal, and increasingly calls a private credit fund instead of arranging a syndicated bank loan — it's faster, more certain, and the terms are negotiated privately. That tight relationship between private equity and private credit is the engine of the category's growth, and also one of its concentrations of risk: the same forces own the borrower and arrange the loan.

Where the return comes from

A private credit loan typically pays a floating rate — a base rate plus a spread of several percentage points — and sits senior and secured, meaning it gets paid back before equity and is backed by the company's assets. The yield is built from three things stacked together:

• The base rate. When central-bank rates are high, these loans pay more, automatically, because the rate floats. That's why the asset class looked so attractive through a high-rate stretch — and why falling rates quietly compress the headline yield.
• The spread. Compensation for lending to a single company without the liquidity of a public bond.
• The illiquidity premium. Your capital is locked up for years. You get paid for being unable to sell in a panic.

Senior-secured sounds safe, and in a healthy economy it largely is — recovery rates on first-lien loans are real. But "secured" is only as good as the collateral and the documents behind it, and both get tested only when something goes wrong.

The pitch is "equity-like returns with debt-like risk." Believe the first half only as much as you trust the manager's underwriting — in private credit, the loan is only ever as good as the diligence nobody can see.

Where the risk hides

Private credit's danger isn't volatility — it's opacity. The loans don't trade on a screen, so you rarely see a price move until something breaks.

• Mark-to-model. A loan's value is an estimate the manager publishes, not a market quote. Smooth returns can mean genuine stability or a number that simply hasn't been marked down yet. Two funds holding the same loan have, at times, reported it at different values — a tell that the "price" is a judgment call.
• Covenant erosion. In the boom, lenders competed by dropping the protective terms ("covenants") that let them act early when a borrower weakens. Looser terms mean problems surface later and cost more.
• PIK and extend-and-pretend. When a borrower can't pay cash interest, some loans let it pay in more debt (payment-in-kind). That keeps the loan "performing" on paper while the underlying business deteriorates. A rising share of PIK income across a fund is a yellow flag worth watching.
• Retail on-ramps. Interval funds and non-traded BDCs now bring everyday investors into an asset built for locked-up institutional capital. The mismatch between a daily-ish redemption promise and a multi-year loan book is the thing to watch — if too many holders ask for their money at once, the fund can gate withdrawals, and the people who needed the cash are the ones who can't get it.

What hasn't been tested

The honest caveat on the whole asset class: most of it has grown up during a stretch with no deep, prolonged default cycle. The models assume recoveries and correlations that a real recession would stress all at once — defaults rising while collateral values fall while redemption requests spike. Private credit may handle that fine. It also may not have happened yet at scale. "No losses so far" and "no losses possible" are very different statements, and the gap between them is where the next chapter gets written.

The reader's takeaway

Private credit is real, large, and here to stay — but it's an asset class where the headline yield and the actual risk live in different places. The number a fund advertises is the spread. The number that matters is how it underwrites, marks, and protects the loans you'll never get to see.

That gap between the marketed return and the buried risk is exactly the kind of thing the newsletter exists to keep honest.