Private-CreditMedium

3 min read · 531 words

What the seat actually does

A private credit fund lends money directly to a company and keeps the loan. There is no syndication, no listing, no daily price — the fund underwrites it, holds it, and is repaid or is not.

It exists because banks stepped back. Post-2008 capital rules made holding leveraged loans expensive for banks, and a borrower too small or too complicated for the bond market still needed the money. The lending did not stop; it moved to funds whose investors accepted that they could not get out early.

• Origination — usually alongside a private equity sponsor buying a company, which is where most of the volume is.
• Underwriting — the cash flow, the collateral, and above all the documentation.
• Holding — monitoring covenants and the monthly numbers for years.
• Working out the bad ones — with no market to sell into, the fund is the one in the room.

A day, and where it goes

• Pipeline — deals shown by sponsors and advisers, most of which will be passed on.
• Credit work — leverage, coverage, and what the earnings figure has been adjusted by. See LBO analysis.
• Documentation — the negotiation that decides what happens when things go wrong, which is the whole of the value in a bad year.
• Portfolio monitoring — the covenant tests, and the conversation that starts before one is missed rather than after.

What it is measured on

• Yield, and how much of it is cash — a coupon paid in kind rather than in money is a return that has not arrived.
• Loss rate through a cycle, which is the only test that matters and takes a cycle to run.
• Recovery when it goes wrong — see credit spreads and loss given default.
• Whether the marks moved. A book of loans held at par through a downturn is a book nobody re-underwrote.

What it touches on this site

• The instruments — private credit funds, leveraged loans and unitranche structures.
• Who else lends — leveraged finance on the sell side, and CLOs, which buy the syndicated version.
• The documents — reading a credit agreement.
• When it breaks — the 2020 uptiering, and restructuring.

How it goes wrong

• Covenant-lite by default. Nothing is tested quarterly, so the first sign of trouble arrives later and larger.
• Add-backs nobody capped. An earnings figure adjusted for synergies that have not happened is a covenant measured against a forecast.
• Valuation by the manager who is paid on it. No market price, quarterly marks, and a fee on the value.
• Liquidity promised to holders that the assets cannot support — the mismatch that has ended several funds on this site.

Concepts to master

• The document is the asset. Two loans at the same spread with different covenant packages are different instruments.
• Floating rate is not no rate risk. It removes duration and adds the risk that the borrower cannot pay the higher coupon.
• Illiquidity premium has to be earned, and separating it from credit risk taken quietly is most of the analysis.
• Sponsor relationships cut both ways — repeat flow, and pressure to accept the terms that come with it.