Private Credit: Characteristics and Risks

What it says

Fed Board economists describe the private credit market using a sample of about 17,000 US loans made by private debt funds and business development companies between 2013 and 2023. Private credit is negotiated bilaterally or in small clubs, mostly senior secured and almost entirely floating rate, and was built for middle-market firms before moving up to larger borrowers once served by leveraged loans. Most borrowers in the sample are backed by a private equity sponsor. Spreads sit above those on syndicated term loans, reflecting riskier borrowers, and private equity deals saw the largest rise in borrowing costs during the 2022 hiking cycle. Defaults have so far been low, helped by covenants and easy renegotiation, but interest coverage has fallen and recoveries are weak because many borrowers in software, financial services and healthcare services hold few tangible assets. The authors flag growing dry powder, looser underwriting and ties to banks.

What to take from it

1. 1

   Total private credit reached nearly $1.7 trillion, comparable with leveraged loans at about $1.4 trillion and high-yield bonds at about $1.3 trillion; direct lending is about half.

2. 2

   Average loan size has exceeded $80 million since 2022, and the average maturity is around five years.

3. 3

   Mean interest coverage, EBITDA over interest, is around 2.0x for private credit borrowers, against about 2.7x for leveraged loan borrowers in 2023.

4. 4

   Post-default value is around 33 percent for direct loans, versus 52 percent for syndicated loans and 39 percent for high-yield bonds.

5. 5

   Dry powder has nearly quadrupled since 2014, raising the risk that managers chase deals with covenant-lite terms and weaker underwriting.

Put it to work on L3VLUP

• Private credit
• Credit model
• Interest coverage ratio
• LBO interview questions