Private Credit and Direct Lending
Private credit funds lend directly to companies outside the banking system and public bond markets, capturing a premium for illiquidity and complexity that has made the asset class one of the fastest-growing corners of finance.
Prerequisites: Credit Risk Fundamentals
A mid-sized company wants to borrow $100 million to fund an acquisition. A generation ago, it would have gone to a bank or issued bonds into the public market. Increasingly, it instead goes to a private credit fund — a pool of institutional capital that negotiates the loan directly, holds it to maturity rather than trading it, and charges a premium for lending outside the regulated, liquid parts of the credit market.
Private credit is lending done directly between a fund and a borrower, outside public bond markets and largely outside the bank balance sheets that used to dominate this space. Investors accept giving up liquidity and public price transparency in exchange for a yield premium and lender-friendly terms negotiated deal by deal.
Why this market exists
After the 2008 financial crisis, tighter capital rules made it more expensive for banks to hold leveraged loans to mid-sized companies on their balance sheets. That gap didn't close the demand for credit — it created an opening for non-bank lenders, largely private funds raised from pensions, insurers, and endowments, to step in and lend directly. Because these loans aren't traded on an exchange, the lender can negotiate covenants, pricing, and collateral terms bilaterally, and typically holds a floating-rate loan, meaning the coupon resets with a reference rate rather than staying fixed.
Worked example
A private credit fund lends $150 million to a mid-market manufacturer at a rate of SOFR plus 600 basis points, with SOFR currently at 5.0% — an all-in coupon of 11.0%. The loan is senior secured, meaning the fund has first claim on the company's assets ahead of other creditors if it defaults, and carries covenants requiring the company to maintain a minimum interest-coverage ratio. Compare this to a public high-yield bond from a similarly-rated issuer yielding 8.5%: the private loan pays roughly 250 basis points more, compensating the fund for holding an illiquid asset it can't easily sell if it needs the cash back, and for taking on a single, concentrated borrower rather than spreading risk across a diversified, publicly-traded pool.
What this means in practice
Because private credit isn't marked to a live market price the way a public bond is, its reported valuations are set by fund managers using models and comparable transactions — smoothing out the volatility a public bond would show and making the asset class look, on paper, steadier than it might actually be. This has drawn regulatory scrutiny as the sector has grown into the trillions, with concerns centering on how accurately those valuations reflect real stress, particularly if a wave of borrowers in the space starts struggling at once.
The absence of daily price volatility in private credit is not the same as the absence of risk — it's an absence of a market forcing the risk to be marked. A private loan can be just as exposed to a borrower's default as a public bond with the same credit profile; it simply won't show the losses on paper until the fund manager marks it down or the loan actually defaults.
Related concepts
Practice in interviews
Further reading
- Preqin, 'Global Private Debt Report'