The course so far has taken private credit apart one strategy at a time. This lesson puts the pieces back together. It compares every strategy on the same few questions: what the lender is relying on, where it ranks, how it makes money, how it loses money, how easily the position can be sold, and how much it suffers in a downturn.
That's how allocators, consultants and investment committees see private credit. An LP-side analyst comparing a senior direct lending fund with an asset-based finance fund needs a common frame. So does a product or IR team explaining where a new fund fits. The comparison below is qualitative and illustrative: it describes how strategies commonly behave, but individual funds and deals vary widely.
The strategies side by side
The two tables below cover the strategies from lessons 1.1 to 5.3. "Liquidity" means how easily a lender could sell the position; almost all private credit is illiquid, so the column mostly shows degrees of "low." "Cycle sensitivity" means how much losses tend to rise in a recession.
How each strategy earns its return
| Strategy (lesson) | Lends against | Seniority | Return mainly from |
|---|---|---|---|
| Sponsor direct lending (1.1) | Cash flow of a sponsor-owned company | Senior secured | Spread and fees |
| Non-sponsor direct lending (1.1) | Cash flow of a founder or family business | Senior secured | Spread and fees, often tighter terms |
| Unitranche last-out (1.2) | The same collateral as the first-out | First lien, paid after the first-out | Higher spread than first-out |
| Second lien (2.1) | Company value, shared collateral | Secured, behind first lien | Higher spread |
| Mezzanine (2.1) | Company value below the secured debt | Subordinated, usually unsecured | Cash and PIK interest, sometimes warrants |
| Holdco PIK and preferred equity (2.2) | Equity value of the operating company | Structurally subordinated | PIK interest or dividends |
| Distressed (2.3) | Recovery value of a stressed company | Varies with the debt bought | Discount to par |
| Rescue financing (2.4) | Company assets, often with priority | Often super-senior | High pricing, fees, sometimes equity |
| Asset-based lending (3.1) | Receivables and inventory | Senior secured | Spread and fees |
| Asset-backed finance (3.2) | Pools of loans, leases or royalties | Senior tranche above first-loss equity | Spread |
| Venture and growth debt (3.3) | Enterprise value and investor support | Usually senior secured | Interest, fees and warrants |
| Niche strategies (3.4) | Legal claims, insurance risks, goods, aircraft, ships | Varies | Varies, often fees or a share of outcomes |
| Senior real estate debt (4.1) | A property and its NOI | Senior mortgage | Spread |
| Real estate mezzanine and bridge (4.1) | Owner's equity; properties in transition | Behind the senior loan | Higher spread and fees |
| Infrastructure debt (4.2) | Contracted or regulated cash flows | Usually senior | Spread |
| Subscription lines (5.1) | LPs' uncalled commitments | Senior | Spread |
| NAV loans (5.2) | A fund's portfolio | Behind portfolio companies' debt | Spread |
| GP financing (5.3) | Fee income and fund distributions | Senior at the manager | Spread |
How each strategy loses money
| Strategy (lesson) | What drives losses | Liquidity | Cycle sensitivity |
|---|---|---|---|
| Sponsor direct lending (1.1) | Weak performance; loose terms | Low | Moderate |
| Non-sponsor direct lending (1.1) | Weak performance; key people | Low | Moderate |
| Unitranche last-out (1.2) | Lower recoveries than the first-out | Low | Moderate to higher |
| Second lien (2.1) | Thinner cushion; lower recoveries | Low | Higher |
| Mezzanine (2.1) | Low recoveries | Low | Higher |
| Holdco PIK and preferred equity (2.2) | Little value left after operating company debt | Very low | High |
| Distressed (2.3) | Overpaying; lower or slower recovery | Low to moderate | High, but downturns create opportunities |
| Rescue financing (2.4) | The business fails anyway | Low | Opportunities rise in downturns |
| Asset-based lending (3.1) | Collateral quality, fraud | Low | Lower to moderate |
| Asset-backed finance (3.2) | Pool losses beyond the first loss; the originator | Low to moderate | Depends on the assets |
| Venture and growth debt (3.3) | Company runs out of cash | Low | High, tied to venture funding |
| Niche strategies (3.4) | Specialist risks; hard-to-value assets | Very low | Often lower |
| Senior real estate debt (4.1) | Fall in property value | Low | Moderate |
| Real estate mezzanine and bridge (4.1) | Thin cushion; business plan fails | Low | Higher |
| Infrastructure debt (4.2) | Construction problems; CFADS shortfall | Low | Lower |
| Subscription lines (5.1) | LPs failing to fund; document flaws | Low, but short term | Lower |
| NAV loans (5.2) | Fall in NAV; slow exits | Low | Moderate to higher |
| GP financing (5.3) | Weak fundraising; key people leaving | Very low | Moderate |
A few patterns stand out:
- Lower in the stack means more of the return is back-ended. Senior lenders are paid mainly in cash each quarter. Mezzanine, holdco PIK and preferred equity rely more on PIK interest, warrants or a payoff at exit, so more of the return depends on the end of the deal going well.
- Some strategies lend against the company; others lend against assets or contracts. Direct lending, second lien and mezzanine depend on a company's cash flow and value. ABL, asset-backed finance, real estate, infrastructure and fund finance depend on specific assets, pools or contracts. That changes what the lender underwrites and what it can recover.
- Opportunistic strategies behave differently in a downturn. Distressed and rescue lenders can lose money on existing positions, but recessions also create their best buying opportunities.
Expected loss by strategy
PC101 4.1 gave a simple formula for the expected annual loss on a portfolio:
Annual loss rate ≈ default rate × (1 − recovery rate)
The following example is illustrative. Using illustrative inputs for three strategies:
| Strategy | Default rate | Recovery rate | Loss given default | Expected annual loss |
|---|---|---|---|---|
| Senior direct lending | 2% | 70% | 30% | 2% × (1 − 70%) = 0.60% |
| Mezzanine | 4% | 40% | 60% | 4% × (1 − 40%) = 2.40% |
| Senior ABF tranche | 1% | 80% | 20% | 1% × (1 − 80%) = 0.20% |
These inputs are chosen to show how position drives losses, not to describe any market. The mezzanine loss is four times senior direct lending's, because it's assumed to default twice as often and to lose twice as much when it does (60% of the claim against 30%). The senior ABF tranche has the lowest loss because first-loss equity and excess spread sit beneath it (lesson 3.2), so it's hit less often and recovers more.
Why a higher yield isn't automatically a better return
A strategy's yield has to pay for its losses before it pays the investor. Using the illustrative yields that lesson 6.2 uses for the same strategies, 10% for senior direct lending and 13% for mezzanine:
| Senior direct lending | Mezzanine | |
|---|---|---|
| Yield | 10.0% | 13.0% |
| Expected loss | 0.6% | 2.4% |
| Return after expected losses | 9.4% | 10.6% |
On these averages, mezzanine earns 1.2 percentage points more after losses, not the 3.0 points its yield suggests.
Averages can hide the worst years. PC101 4.1 showed that losses rise sharply when default rates rise and recoveries fall together. Suppose a recession doubles each strategy's default rate and cuts recoveries: senior direct lending to 4% defaults and 50% recovery, mezzanine to 8% defaults and 20% recovery. The illustrative results:
| Recession case | Senior direct lending | Mezzanine |
|---|---|---|
| Expected loss | 4% × (1 − 50%) = 2.0% | 8% × (1 − 20%) = 6.4% |
| Return after losses | 8.0% | 6.6% |
In the recession case, the lower-yielding strategy returns more. That's the point allocators keep in mind: extra yield is payment for extra risk, and whether it's enough depends on how the strategy behaves when defaults cluster, not on the average year. It also ignores fees, which can differ by strategy, and the other risks lesson 6.2 discusses.
Key terms
- Seniority: Where a claim ranks in repayment; senior claims are paid first.
- Return driver: The main source of a strategy's return, such as spread, fees, PIK, equity upside or a discount to par.
- Liquidity: How easily a position can be sold at a fair price.
- Cycle sensitivity: How much a strategy's losses tend to rise in a recession.
- Expected annual loss: The average yearly loss rate, approximated as default rate × (1 − recovery rate).
- Return after losses: Yield minus expected losses, before fees.
Key takeaways
- Every strategy can be described by what it lends against, where it ranks, how it earns, how it loses, how liquid it is and how it behaves in a downturn.
- With illustrative inputs, expected annual losses are 0.60% for senior direct lending, 2.40% for mezzanine and 0.20% for a senior ABF tranche.
- A 13% mezzanine yield less 2.4% losses returns 10.6%, only 1.2 points more than senior direct lending's 9.4%.
- In a recession case, mezzanine's return after losses (6.6%) can fall below senior direct lending's (8.0%).
- Higher yield pays for higher risk; judge it against losses in bad years, not just the average.
This lesson is for educational purposes only and is not investment advice.