1.1 A framework for credit decisions

Every loan starts with a decision. A lender is not asking whether a company is exciting or whether its owners will make a lot of money. It asks two plainer questions: will this company repay me, and what happens if it can't? Credit analysis is the work of answering them well enough to put money at risk, and underwriting is the process of turning that analysis into a decision and a set of terms.

This skill sits behind every private credit strategy covered in PC201. Analysts and associates do the work directly. LP-side analysts judge whether a manager does it well. Investor relations and product teams explain it to investors, and service providers read the memos, models and quality of earnings reports that come out of it. This lesson sets out a framework for the decision and introduces the deal you will follow through the whole course.

What a lender is really deciding

A lender's payoff is lopsided. If the borrower does well, the lender gets its interest, its fees and its money back, and no more. If the borrower does badly, the lender can lose part of its principal. PC101 4.1 showed how this links default, recovery and expected loss.

That shapes how lenders think:

• Repayment comes first. The question is whether the company produces enough cash to pay interest and, over time, repay or refinance the loan.
• The downside matters most. A lender gains little from a great outcome, so it spends most of its time on the bad ones.
• Protection is part of the answer. Where the loan ranks, how much equity sits below it, and what rights the lender has if results slip all affect how much it loses when things go wrong.

The five questions

Most credit decisions come down to five questions. Credit teams group them in different ways, but the ground they cover is broadly the same.

Question	What the lender asks	Examples
The business	Is this a durable company in a sensible industry, with an owner who will support it?	Recurring revenue, customer concentration, competition, the sponsor's record
The numbers	How much real earnings and cash does it produce?	Adjusted EBITDA, free cash flow, leverage, interest coverage
The structure	What protects the lender if results fall?	Ranking and security, the equity cushion, covenants, limits on extra debt
The downside	What happens in a bad case, and what does the lender recover in a default?	Stress tests, covenant headroom, liquidity, recovery analysis
The price	Is the lender paid enough for the risk?	Spread, fees, expected loss, how the deal compares with others

The questions connect. A strong business can support more debt. A weak structure can turn a manageable problem into a loss. And price comes last for a reason: a higher spread can't rescue a loan that fails the first four questions, because the extra income is small next to the principal at risk.

The deal: Corbel Facility Services

The following example is illustrative.

Corbel Facility Services is a fictional provider of commercial cleaning and building maintenance. It works for offices, schools, hospitals and other buildings under multi-year service contracts. The private equity firm Linden Row Partners, also fictional, has agreed to buy it.

To fund the purchase, Linden Row has asked several lenders for proposals. Hollin Bay Capital, the fictional multi-strategy credit manager from PC201, is considering the following for its direct lending fund:

Term	Proposal
Facility	$220m unitranche (PC201 1.2)
Pricing	SOFR + 550 bps: 9.50% all-in with term SOFR at 4.00%
Annual interest	9.50% × $220m = $20.9m
Revolver	$30m, undrawn at closing
Borrower	Corbel Facility Services, owned by Linden Row Partners

Corbel's reported EBITDA is $36.0m on revenue of $300.0m. Linden Row presents a higher "adjusted" figure of $47.0m and is paying 10.0x that number, a purchase price of $470.0m. The unitranche funds $220.0m of it and Linden Row's equity the other $250.0m.

Hollin Bay's deal team now has to decide whether to lend, how much, and on what terms. It will work through each of the five questions, and so will you.

How this course follows the framework

Each module takes up part of the framework and applies it to Corbel.

Framework question	Where it's covered
The business	Lesson 1.2 (business and industry) and lesson 1.3 (the sponsor)
The numbers	Lessons 2.1–2.5 (statements, EBITDA, quality of earnings, free cash flow, recurring revenue) and lessons 3.1–3.2 (leverage and coverage)
The structure	Lesson 3.3 (loan-to-value and the equity cushion), with covenants tested in lesson 4.2
The downside	Lesson 4.1 (the base case model), lesson 4.2 (downside cases) and lesson 4.3 (recovery)
The price	Lesson 5.1, where the credit memo weighs risk against return

Module 5 then pulls the answers together into a credit memo and a presentation to investment committee (PC101 4.3 described where this sits in the deal lifecycle). The course ends with Quillmark Software, a different fictional borrower, so you can apply the framework on your own.

Two habits will help throughout. First, write down the assumption behind every number: when Corbel's EBITDA is $47.0m in one place and $44.0m in another, the difference is a judgment, not an error. Second, ask what would have to go wrong. Lenders don't need to predict the future. They need to know how much bad news a loan can absorb.

Key terms

• Credit analysis: assessing a borrower's ability to repay and what a lender recovers if it can't.
• Underwriting: turning credit analysis into a lending decision and a set of terms.
• Credit framework: a set of questions (business, numbers, structure, downside and price) that guides a credit decision.
• Downside case: a projection that tests what happens to the borrower if results are worse than expected.
• All-in rate: the base rate plus the spread, here SOFR 4.00% + 5.50% = 9.50%.

Key takeaways

• A lender decides whether a company will repay and what happens if it can't; its upside is capped and its downside is not.
• Most credit decisions answer five questions: the business, the numbers, the structure, the downside and the price.
• Price comes last because a higher spread can't fix a loan that fails the other four questions.
• In the running example, Hollin Bay Capital is considering a $220m unitranche at SOFR + 550 bps (9.50%, or $20.9m of interest a year) for Linden Row's purchase of Corbel Facility Services.
• The rest of the course works through the framework in order, ending with a credit memo for investment committee.