2.2 Lenders

Private credit is often called "non-bank lending", but that label hides a lot of variety. The money comes from several kinds of lenders, each with its own structure, rules and reasons for lending. The type of lender affects how loans are funded, how long they are held and how results are reported.

If you work in operations, investor relations or on the investor side, you will deal with these structures directly. This lesson introduces the four main groups: direct lending funds, business development companies, insurers, and partnerships between banks and private credit managers.

Direct lending funds

The most common private lender is a direct lending fund run by an asset manager. Most are structured as closed-end funds: investors commit money for a fixed period, usually several years, and cannot withdraw it early.

These funds are typically set up as limited partnerships:

• The general partner (GP) is the asset manager. It runs the fund, finds borrowers, makes lending decisions and monitors loans.
• The limited partners (LPs) are the investors, such as pensions and insurers. They provide most of the money but do not run the fund.

The fund does not receive all its money at once. LPs make a commitment, and the GP makes capital calls to draw that money as it finds loans to make. As borrowers repay, the fund returns money to LPs as distributions. This is why these funds are often called drawdown funds.

The GP is paid a management fee, usually a percentage of assets or committed capital, and often an incentive fee based on performance. Many funds also borrow modestly against their loans to increase returns, which is called fund-level leverage.

Managers also run other vehicles. Evergreen funds have no fixed end date and let investors join or redeem periodically, usually with limits. Separately managed accounts (SMAs) are portfolios run for a single large investor. PC203 covers these in depth.

Business development companies (BDCs)

A business development company (BDC) is a US closed-end investment vehicle regulated under the Investment Company Act of 1940. BDCs were designed to channel capital to smaller and mid-sized US businesses, and today many of them are major direct lenders.

Key features of BDCs:

• What they invest in. A BDC must invest mostly in US private companies or small public companies.
• Tax treatment. Most BDCs elect to be taxed as a regulated investment company (RIC). A RIC generally pays little or no corporate income tax if it distributes at least 90% of its taxable income to shareholders. That is why BDCs pay out most of their income as dividends.
• Leverage limits. The 1940 Act caps how much a BDC can borrow relative to its assets.
• Regular reporting. BDCs report their holdings and results to shareholders and regulators, which makes them one of the more transparent parts of private credit.

BDCs come in three forms:

Because some BDCs are open to individuals, they are a key route for private wealth into private credit, a topic covered in Lesson 2.3.

Insurers

Insurance companies, especially life insurers, are among the largest investors in private credit. They lend in two ways: by investing in funds run by asset managers, and by lending directly or through affiliated managers.

Life insurers are well suited to private credit because of their liabilities, the payments they owe policyholders. These payments stretch years or decades into the future and are fairly predictable. An insurer does not need to sell assets at short notice, so it can hold loans it cannot easily sell and earn extra yield for doing so.

Insurers mostly want steady income and high credit quality. They often focus on investment-grade private credit, senior loans and structures that receive a credit rating. The capital rules insurers follow, which differ by country, strongly shape what they buy. In recent years, some insurers and asset managers have formed close ties, including ownership links, so that the manager can originate loans that suit the insurer's balance sheet.

Bank–private credit partnerships

Banks have not left the market. They still have deep client relationships and large teams that find and arrange deals. What changed is the cost of holding riskier loans on their own balance sheets.

In recent years, a number of banks and private credit managers have formed partnerships. Structures vary, but a typical arrangement works like this:

• The bank uses its client relationships and origination teams to find borrowers.
• The private credit manager provides the capital to hold the loans, often through a dedicated fund or joint venture.
• The bank keeps the client relationship and may earn fees or keep a smaller share of the loan.

These partnerships show that banks and private lenders are not only rivals. They increasingly work together, each doing what it does best.

Other lenders

You will also meet other lenders. Middle-market CLOs buy pools of private loans and fund them by issuing notes. Pension funds and sovereign wealth funds sometimes lend alongside managers through co-investments. And some private equity firms run their own credit businesses. PC203 covers these vehicles in more detail.

An example

The following example is illustrative.

Northfield Components needs a large unitranche loan (a single loan that combines senior and junior debt in one facility). The loan is shared among several holders:

• A direct lending fund managed by an asset manager takes the largest piece.
• A BDC run by the same manager takes another piece, so both vehicles invest in the same deal on the same terms.
• A life insurer, through an SMA with that manager, takes a smaller slice.

Northfield sees one lender group and one set of terms. Behind the scenes, three different vehicles, each with its own investors and rules, hold the loan.

Key terms

• Direct lending fund: A fund run by an asset manager that makes loans directly to companies.
• General partner (GP): The manager that runs a fund and makes its investment decisions.
• Limited partner (LP): An investor in a fund who provides capital but does not run it.
• Capital call: A request from the GP for LPs to fund part of their commitment.
• Business development company (BDC): A US closed-end vehicle regulated under the Investment Company Act of 1940 that invests mostly in US private or small public companies.
• Regulated investment company (RIC): A US tax status that generally avoids corporate income tax if the vehicle distributes at least 90% of its taxable income.
• Separately managed account (SMA): A portfolio run by a manager for a single investor.
• Bank–private credit partnership: An arrangement where a bank sources loans and a private credit manager provides capital to hold them.

Key takeaways

• Direct lending funds, usually closed-end limited partnerships, are the most common private lenders.
• BDCs are 1940 Act vehicles that invest mostly in US private or small public companies and pay out most of their income.
• Life insurers lend because their long, predictable liabilities let them hold illiquid loans.
• Banks and private credit managers increasingly work together, combining origination with capital.
• A single loan is often held by several vehicles run by the same manager.