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GCN Investor Conference in Newport Beach, CA
OCT 15 · NEWPORT BEACH, CA
LIVE EVENT
Private credit did not grow because investors discovered it. It grew because post-crisis regulation made a category of lending uneconomic for banks, and the loans still needed making. Understanding that origin explains almost everything about the asset class since.
Private credit — direct lending by non-bank institutions to companies, mostly leveraged and mostly to private-equity-owned borrowers — was growing rapidly by 2016 and had established itself as a permanent institutional allocation rather than a niche.
The origin story matters more than the growth rate, because it determines whether the growth is durable.
After the financial crisis, regulation raised the capital banks must hold against risky lending. A leveraged loan to a mid-market company became substantially more expensive for a bank to hold on its balance sheet, and in many cases uneconomic relative to the return.
The demand for those loans did not disappear. Private-equity-owned companies still needed acquisition and refinancing debt. Mid-market businesses still needed capital. The borrowers remained; the traditional lender withdrew.
That gap is the asset class. Non-bank lenders — credit funds, business development companies, insurance-affiliated managers — stepped into lending that banks had retreated from, and were paid a spread for doing so.
Two forces met at the right moment. The regulatory change created the supply of loans needing a lender. The yield environment described in the 2016 global report — with safe assets yielding little or nothing — created institutional demand for exactly the sort of return direct lending offered.
This origin is the strongest argument for the asset class's durability. Regulatory capital requirements are not a cycle. Unless they are reversed, the lending will not return to banks, and the non-bank lender's position is structural.
It is worth being precise about what that argument does and does not establish. It establishes that the supply of loans is durable. It says nothing about whether they are priced correctly, underwritten well, or will perform through a default cycle. Those are separate questions, and in 2016 all three were unanswered.
Direct lending offered a yield above comparable syndicated loans. Understanding the source of that spread determines whether it represents genuine compensation or unpriced risk.
Several components are genuine compensation:
Others are less clearly compensation:
That last point deserves emphasis because it recurs throughout the asset class's history.
A direct loan is valued by a model. A traded loan is valued by a price. The model produces a smoother series. Smoothness is not stability — it is the absence of measurement.
The practical consequence: Sharpe ratios and volatility statistics for direct lending are not comparable to those for traded credit, because the denominators are produced by different processes. A comparison that treats them as equivalent systematically favours the model-valued asset.
By 2016, direct lending managers made three claims about their advantages over syndicated markets. All three were plausible. None had been tested.
Claim one: better underwriting. A direct lender holding the whole loan has stronger incentives to underwrite carefully than a syndicated participant holding a small piece of a loan originated by someone else. The originate-to-distribute model that contributed to the financial crisis is the counterexample that makes this argument compelling.
The counter-argument: underwriting quality depends on the underwriter, not on the holding structure. A lender under pressure to deploy capital may underwrite poorly regardless of how much of the loan they keep. And by 2016, capital was flowing into the asset class faster than mid-market loan supply was growing — which creates exactly that pressure.
Claim two: better workout outcomes. A concentrated lender can act decisively when a borrower deteriorates, negotiating directly rather than coordinating a fragmented syndicate.
The counter-argument: concentration removes the option to exit. A syndicated lender who becomes concerned can sell. A direct lender cannot, and must therefore see the situation through whether or not that is the best use of their attention and capital.
Claim three: relationship lending produces better information. A direct lender with an ongoing relationship, board observer rights and regular reporting knows more about the borrower than a public market participant.
The counter-argument: better information is only valuable if it changes decisions. A lender who cannot sell and will not force a default has limited ability to act on what they learn.
All three claims share a dependency: they can only be evaluated in a default cycle. In 2016, and for years afterward, defaults were low. The asset class's performance record was generated entirely in benign conditions.
This is the observation that the 2024 and 2026 reports return to, and it remains the central open question about the asset class a decade later.
Understanding who the lenders are clarifies how the asset class behaves under stress.
Business development companies (BDCs) are US-listed or non-traded vehicles that lend to mid-market companies. Listed BDCs have a useful property for analysts: they are publicly traded and file quarterly reports. This makes them the most transparent window into private credit that exists — portfolio composition, individual loan marks, non-accrual rates and payment-in-kind income are all disclosed.
Private credit funds are closed-end vehicles resembling private equity funds in structure — committed capital, drawdown, a defined investment period. They are opaque, reporting only to their LPs.
Insurance-affiliated managers allocate insurance general account assets to private credit. Their liabilities are long-dated, making illiquid assets a genuinely good match — this is arguably the most natural fit for the asset class of any capital source.
Bank partnerships emerged, in which banks originate and immediately distribute to non-bank holders, retaining the client relationship without the balance sheet cost.
The listed BDC disclosure point is worth flagging for anyone researching this asset class: it is the only place where individual private loan marks are public. A researcher wanting evidence about private credit valuations, PIK usage or non-accrual trends can obtain it from BDC filings without paying for a data subscription, and cannot obtain it any other way.
A private credit allocation is frequently assessed at the asset-class level. The risks sit at the loan level, and the components are worth enumerating because they determine how a portfolio behaves in stress.
The borrower. Typically a mid-market company, frequently owned by a private equity sponsor, leveraged at a multiple of earnings determined at the time of the transaction. The borrower's ability to service the loan depends on earnings holding up and on the interest cost, which — since most direct loans are floating rate — is not fixed.
The structure. Senior secured in most cases, meaning the lender ranks ahead of other creditors and holds security over assets. Seniority determines recovery in default and is the single most important structural feature.
The documentation. What the borrower is required to do and what triggers lender rights. As the 2017 US private equity report describes, maintenance covenants — tested regularly regardless of what else happens — give lenders early intervention rights. Incurrence-only documentation does not. The same credit with different documentation is a materially different investment.
The sponsor. A private-equity-owned borrower has an owner with capital and a reputational interest in supporting portfolio companies. That support is real and it has limits: a sponsor facing an impaired investment near the end of a fund's life has diminishing reason to contribute more.
The lender's own position. Whether the lender holds the loan in a closed-end fund with committed capital, in a listed vehicle with a market price, or in a semi-liquid structure with redemption terms. This determines whether the lender can hold through stress or is a forced seller, and it is a property of the fund rather than of the loan.
Why the enumeration matters: an aggregate statistic about private credit — a yield, a default rate, a loss rate — blends loans that differ on every one of these dimensions. Two portfolios reporting the same yield can have entirely different behaviour in a default cycle depending on seniority, documentation, sponsor quality and the lender's own funding structure.
The asset class question is whether private credit is attractive. The answerable question is whether a specific portfolio of loans, with specific documentation, held in a specific structure, is attractive. Only the second has a determinate answer.
Read BDC filings. Listed business development companies file quarterly and disclose individual loan marks, non-accrual status, PIK income share and portfolio composition. This is the only public window into private credit valuation practice and it is free on SEC EDGAR. An investor considering a private credit allocation who has never read a BDC filing has not examined the asset class's primary evidence.
Compare the private mark series to a traded loan index over the same periods. The Cliffwater Direct Lending Index and the S&P/LSTA leveraged loan index cover overlapping exposures with different valuation methods. Where the private series is smoother, the difference is measurement rather than risk. This comparison is free and is the cleanest available test of the smoothing question.
Do not compare Sharpe ratios across valuation methods. A model-valued asset produces a smoother return series, which produces a better ratio at the same return. Portfolio optimisation using unadjusted inputs over-allocates to the model-valued asset as a mathematical consequence, not as a judgement.
Ask what the documentation requires. Maintenance covenant or incurrence-only. Whether financial tests exist and what they trigger. This determines when a lender learns about deterioration and whether they can act — and it is the difference between a default statistic that means what it historically meant and one that does not.
Separate the structural case from the performance record. The regulatory origin argument is genuinely strong: bank retrenchment from leveraged lending is a rule change, not a cycle, so the supply of loans needing a non-bank lender is durable. That argument establishes the asset class will exist. It says nothing about whether the loans are priced correctly or will perform — and those are the questions a default cycle answers.
A structural retrospective on private credit in 2016, focused on why the asset class exists, what its return actually compensates, and which of its claims were unverified.
Where figures appear they carry a numbered source. Mechanisms — regulatory capital and bank retrenchment, illiquidity premium decomposition, model-based valuation and apparent volatility, concentration trade-offs — are analysis with reasoning shown.
This is the first report in the archive's private credit sequence and establishes the questions that the 2020, 2022, 2024 and 2026 reports revisit.
This is the first report in a five-part private credit sequence that tracks the three claims set out above across a decade of deferred tests:
Private Credit Report 2020 — the stress test that began in March and was cancelled by the policy response within weeks. Why the resulting record measures the intervention rather than the underwriting, and how payment-in-kind arrangements began accommodating stress without recognising it.
Private Credit Report 2022 — why floating rate protection is two-sided, why interest coverage rather than leverage became the binding constraint, and the five mechanisms through which the resulting stress was deferred rather than resolved. Also introduces the vintage split that has become the asset class's most important analytical distinction.
Private Credit Report 2024 — what changes when an asset class reaches a scale at which its stress behaviour becomes a systemic question rather than an allocation question, and how bank relationships have complicated the regulatory-origin narrative set out here.
Private Credit Outlook 2026 — the deferral mechanisms approaching their limits, and a specification of exactly what evidence would settle each of the three claims identified in this report.
For the credit market context, the US Private Equity Report 2017 describes the shift to covenant-lite documentation that determines when deterioration becomes visible, and why default statistics compared across that shift are measuring different things.
For the institutional demand that funded the asset class's growth, the Global Investment Outlook 2016 describes the yield problem that converted a large pool of price-sensitive capital into price-insensitive capital, and the Private Equity Report 2015 describes the same mechanism operating one asset class over.
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