Private credit is going through a challenging period as a segment of private markets. My intention is not to dive into this issue itself, but rather take this opportunity to highlight what private credit is in general, so let’s start with a definition.
Private credit refers to loans and debt financing provided by non-bank lenders such as asset managers, private equity firms, or dedicated credit funds, directly to companies without using public debt markets or traditional bank lending. The terms are negotiated privately, the debt is not traded on exchanges, and the lender typically holds it to maturity.
Why companies use it? Around 2008, when the financial crisis occurred, banks pulled back from lending to mid-sized and smaller companies due to tighter regulations such as Basel III and Dodd-Frank. This created a perfect funding opportunity for private credit firms.
In terms of key participants, we have:
- Borrowers - typically mid-market companies, often backed by private equity
- Lenders - credit funds
- Investors in the fund - pension funds, insurance companies, sovereign wealth funds, family offices, and also increasingly retail investors
As we have a lot of strategies used by credit funds such as direct lending, mezzanine, senior / junior debt, distressed debt, real estate debt, infrastructure debt, asset-based finance and much more, I thought that explaining just a few of them would be beneficial:
-
Direct Lending - senior secured loans to mid-market companies. It is the core of private credit. A secured loan means the lender has a legal first claim on the company’s assets (inventory, equipment, IP, cash flows) if the borrower defaults.
-
Mezzanine Debt - it is mostly subordinated, unsecured debt. Sits between senior debt and equity. Because it carries higher risk than senior debt, it typically comes with higher interest rates, sometimes structured as PIK (payment-in-kind). It often includes an equity kicker such as warrants, giving the lender upside if the company does well.
-
Distressed Debt - buying debt of struggling or bankrupt companies at a discount with recovery potential. The typical path is either converting debt to equity and taking control of the company, or pushing through an operational turnaround to recover value before selling.
What brings investors to private credit? From my research, the main draws are:
- Higher yield compared to public debt
- Low intraday volatility
- Low correlation to stocks and public bonds
- Seniority - first claim on assets in case of default
This type of investment also comes with risks:
- Illiquidity - common denominator across private markets, so it is hard to sell a position quickly if you need capital back.
- Credit risk - higher, since borrowers are often highly leveraged and engaged in other private markets deals using Leveraged Buyouts (LBOs).
- Valuation ambiguity - loans are marked by the manager, not the market itself, so this can lead to potentially overstated Net-Asset-Values (NAVs). A public bond has a live market price — you can see it any second. A private loan has no market price. So every quarter, the fund manager must assign a value to each loan in the portfolio. Common approaches include discounted cash flow, where the loan is valued by discounting future cash flows (interest + principal) back to present value using a market discount rate, comparable pricing, where the manager looks at observable prices of similar public debt such as bonds or syndicated loans and applies adjustments, and other methods depending on the asset type and fund strategy.
Nevertheless, this segment of the market has grown dramatically up to over $2 trillion by 2024–2025, making it one of the fastest-growing segments in alternative assets.
Private credit is having a challenging time right now, but understanding what it actually is, how it works, and what risks it carries makes it easier to judge whether those challenges are temporary or something more structural. That is at least what I find valuable in going back to basics.