Private Credit / Leverage
Who lends to the lenders
Direct lending funds are described as unlevered vehicles making senior loans. The leverage sits one level up, and it is where banks re-entered the business they left.
The standard description of private credit is reassuring: long-term capital, locked up, lending senior secured to mid-market companies, with no run risk because there is nothing to run from. Most of that is accurate about the loans. It is incomplete about the funds holding them.
Where the borrowing happens
Funds borrow at the fund level, through subscription lines secured on investor commitments and asset-backed facilities secured on the loan portfolio itself. Insurers hold the exposure through rated note structures that convert a fund interest into something that carries a capital charge they can live with. Banks, having exited the underlying lending, provide much of this financing.
The risk did not leave the banking system. It changed shape, moved one step further from the borrower, and became considerably harder to see.
Ask not whether the loan is senior. Ask who financed the entity holding it, and on what terms.
The mechanism that binds it together
Facility terms depend on the value of the collateral, and the collateral is valued by a model. If marks fall, borrowing capacity falls with them, at exactly the moment the fund would rather not sell anything. That is the same feedback loop that has driven every leveraged credit episode, arriving through a channel with less disclosure than the last one.
Concentration nobody aggregates
A single mid-market borrower can appear in several funds, several rated note structures and several bank facilities at once. No participant sees the whole position, and no regulator collects it in a form that would show the overlap before it matters.
What to watch
- Fund-level leverage ratios, where disclosed, and the trend in them.
- Bank lending to non-bank financial institutions, which is reported in aggregate and has grown considerably.
- Insurance allocations to private credit, and the ratings assigned to the structures that carry them.
- Any move by supervisors to collect look-through exposure data, which would be the first sign that someone official is trying to see the whole picture.