Private credit, and why everyone is nervous about it
Private credit's central feature is that the loans are not priced by a market. That is its selling point and its biggest danger.
Understand what private credit is, and what happens to it when things go wrong.
How Private credit works, in one picture
The same argument as the text, as a chain. Each step is what makes the next one possible.
Why the debt is the engine
Put in 30, borrow 70, secure the loan against the company you are buying. A 30% rise in the business doubles your money. The same arithmetic works in reverse, which is why buyouts fail loudly.
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It is lending to companies, outside the banks
Funds lend directly to businesses, often the ones private equity has bought. The borrowers pay more than they would to a bank, in exchange for speed, flexibility and fewer questions. The lenders earn a chunky yield. Everyone has been very happy.
- 2
The loans are not marked by a market, and that is the whole thing
A traded bond has a price, updated by the second, telling you what people actually think it is worth. A private loan is valued by the fund that holds it, using a model. When conditions deteriorate, a traded bond falls immediately and a private loan often does not.
That produces beautifully smooth returns. It does not produce lower risk. It produces less visible risk, which is not the same thing and is arguably worse.
Smooth reported returns from illiquid assets are the oldest optical illusion in finance. The volatility is still there; you just are not being shown it.
- 3
It has never been through a real recession at this size
The market has grown enormously in a period of cheap money and few defaults. Nobody alive has watched a trillion-dollar private credit market go through a genuine default cycle, because one has never existed before. Anyone who tells you confidently how it will behave is guessing.
- 4
The thing to watch is payment-in-kind
When a struggling borrower cannot pay cash interest, some loans let them pay in more debt instead. The lender books the income anyway. Rising PIK usage means borrowers are struggling and the fund's reported yield has quietly stopped being cash.
You can explain why smooth returns are not the same as low risk.
Read next
Private credit's central feature is that the loans are not priced by a market. That is its selling point and its biggest danger.
Price to book and return on equity read together, which is the only way a bank makes sense.