1.1 Defining private credit

Private credit is one of the fastest-growing parts of asset management. It now funds thousands of companies that once borrowed mainly from banks. If you work at a credit fund, an investor, or a firm that services these funds, you will hear the term every day. But people use it loosely, so it helps to start with a clear definition.

This lesson explains what private credit is, the features that set it apart, and how it differs from the public debt markets. Later lessons build on these ideas, so it is worth getting them straight now.

What private credit is

Private credit is lending by non-bank lenders, where the terms are negotiated privately between the lender and the borrower, and the lender usually holds the loan until it is repaid. You will also hear it called private debt. The two terms mean the same thing.

Let's unpack each part of that definition.

• Non-bank lenders. The money comes from investment funds and other institutions, not from a bank's own balance sheet. Typical lenders are funds run by asset managers, business development companies, and insurance companies. You will meet each of them in Module 2.
• Privately negotiated. The borrower and lender agree the terms directly. There is no public offering, no exchange listing, and usually no credit rating from an agency. The terms are set out in a private contract called a credit agreement.
• Usually held to maturity. The lender plans to keep the loan until the borrower pays it back. It does not buy the loan to trade it. Its return comes from the interest and fees the borrower pays over the life of the loan.

The largest and best-known part of private credit is direct lending: loans made directly to companies, often to finance a purchase by a private equity firm. But the term also covers other strategies, such as junior loans, lending against pools of assets, and real estate debt. This course focuses mainly on direct lending, because that is where most people start. The strategies course (PC201) covers the rest.

The building blocks of a private loan

Most private loans share a few common features. You will study each in detail in Module 3, but here is a first look.

• Floating rate. Interest is usually set as a base rate plus a spread. In the US, the base rate is typically the Secured Overnight Financing Rate (SOFR), a benchmark for short-term interest rates. The spread is a fixed extra amount the lender charges for taking the borrower's credit risk. When SOFR moves, the interest rate on the loan moves with it.
• Senior and secured. Many direct loans are senior secured loans. "Senior" means the lender is repaid before other creditors and shareholders. "Secured" means the loan is backed by the borrower's assets, which the lender can claim if the borrower fails to pay.
• Covenants. These are promises the borrower makes in the credit agreement. For example, the borrower may promise to send financial statements every quarter, or to keep its debt below a set level compared with its earnings. Covenants give the lender early warning when something goes wrong.
• Fees. Lenders often charge an upfront fee or lend at a small discount to the loan's face value. These add to the lender's return.

How private credit differs from public debt

Companies can also borrow in the public debt markets. The two main options for companies with below-investment-grade credit are high-yield bonds and broadly syndicated loans (BSL). A broadly syndicated loan is arranged by a bank and then sold in pieces to many institutional investors, who can trade those pieces afterwards. Lesson 1.3 compares these markets in detail. For now, the key differences are:

The central trade-off is this. Borrowers usually pay more for private credit. In return, they get speed, certainty that the deal will close on agreed terms, confidentiality, and a lender they can call directly. Lenders, in return for giving up the ability to sell easily, earn a higher return and get more information and control.

An example

The following example is illustrative.

Northfield Components is a mid-sized manufacturer of industrial parts. A private equity firm agrees to buy it and needs to borrow part of the purchase price.

The firm could ask a bank to arrange a broadly syndicated loan. But Northfield is fairly small, the bank would need to find many investors, and the terms could change if market conditions worsen before the deal closes.

Instead, the private equity firm approaches a direct lending fund. Over a few weeks, the fund's team studies Northfield's finances, visits its factories, and negotiates terms. The fund agrees to lend the full amount as a senior secured, floating-rate loan. It will receive quarterly financial reports and hold the loan until Northfield repays it, most likely when Northfield is sold or refinanced.

That is private credit in a nutshell: one lender, private terms, detailed information, and a plan to hold the loan until it is repaid.

Why the definition matters for your job

Different roles see private credit from different angles.

• Investment teams decide which loans to make and watch how the borrowers are doing.
• Fund accounting and operations staff record interest, fees and repayments, and help value loans that do not trade.
• Investor relations teams explain the strategy and results to the fund's investors.
• LP-side analysts (people who work for the investors in the funds) judge whether a fund's loans fit their portfolio.

Everyone needs the same core idea. A private loan is a private, negotiated contract that is hard to sell, so its value depends on the borrower's ability to repay and on the lender's skill in choosing and monitoring borrowers.

Key terms

• Private credit (private debt): Lending by non-bank lenders on privately negotiated terms, usually held until repaid.
• Direct lending: Loans made directly by a non-bank lender to a company, the largest part of private credit.
• Credit agreement: The private contract that sets out a loan's terms.
• Base rate: The benchmark interest rate a floating-rate loan is priced from; in the US, usually SOFR.
• Spread: The extra interest a lender charges on top of the base rate for taking credit risk.
• Senior secured loan: A loan that is repaid before other debts and is backed by the borrower's assets.
• Covenant: A promise the borrower makes to the lender in the credit agreement.
• Broadly syndicated loan (BSL): A loan arranged by a bank and sold in pieces to many investors, who can trade it afterwards.

Key takeaways

• Private credit is non-bank lending that is privately negotiated and usually held to maturity.
• Direct lending to companies is its largest part, but the term also covers other strategies.
• Private loans are typically floating rate, often senior secured, and come with covenants.
• Compared with public debt, borrowers pay more but gain speed, certainty and confidentiality.
• Because private loans are hard to sell, returns depend on choosing and monitoring borrowers well.