Private credit has grown quickly, and for understandable reasons. As bank lending has become more constrained and more standardised, borrowers have come to value speed, flexibility and certainty of execution, and are often willing to pay for it. For investors, the appeal is a contractual return that does not depend on an exit valuation or on markets behaving in a particular way.

That appeal is real, but it can also be misleading. A higher yield is not a feature of an investment; it is the price of the risk being taken. The discipline in private credit lies in understanding precisely what that risk is, and whether the return offered is adequate compensation for it.

The asymmetry at the centre of lending

Credit is fundamentally asymmetric. If a loan performs exactly as intended, the lender receives interest and the return of capital, and nothing more. If it does not, the loss can be substantial and permanent.

This asymmetry should shape the entire approach to underwriting. In equity, a strong outcome can compensate for a weak one elsewhere, but in credit there is no equivalent offset. A single serious loss can absorb the margin earned on several performing loans, which is why the emphasis belongs on the downside rather than the base case. The relevant question is not how attractive the coupon looks, but what happens if the borrower's plan does not unfold as expected.

Where repayment actually comes from

Every loan should have a clear and credible source of repayment, identified before any capital is committed. In practice this usually means a sale, a refinancing or cash flow generated by the business or asset, and each carries its own set of dependencies.

If repayment relies on a sale, the underwriting depends on the depth of the buyer market and on values at a future point in time. If it relies on a refinancing, it depends on the availability and cost of credit in conditions that may differ considerably from today's. If it relies on operating cash flow, it depends on the durability of that cash flow through a cycle rather than at its strongest point.

A secondary source of repayment matters just as much. Security over an asset is only as valuable as the price it would realise in a sale that the lender did not choose and could not time. Testing that value on conservative assumptions, rather than on the borrower's expectations, is one of the more useful exercises in credit analysis.

Structure is not a formality

The commercial terms of a loan determine the return, but the structure determines what happens when circumstances change. Seniority, security, guarantees, covenants, amortisation, cash controls and information rights are the mechanisms through which a lender retains influence, and they tend to matter most at precisely the moment they are tested.

Competitive markets have a tendency to erode these protections. When capital is plentiful, covenants loosen, definitions widen and reporting obligations soften, often without any corresponding reduction in risk. Two loans can carry identical pricing while offering very different levels of control, and the difference usually becomes apparent only when a borrower underperforms.

The purpose of structure is not to restrict a borrower unnecessarily. It is to ensure that if performance deteriorates, the lender learns about it early and has the ability to act while options still exist.

Complexity is not the same as risk

Complex situations are often where private credit is most useful. A transaction may involve a tight timetable, an incomplete development, a restructuring, multiple jurisdictions or an asset that does not fit conventional lending criteria. Banks may decline such situations for reasons that have little to do with the underlying credit quality.

Complexity of this kind can be acceptable, provided it is understood and priced. What should not be accepted is complexity that obscures the analysis rather than explaining it. If it is difficult to state clearly how a loan is repaid, what the lender holds as security and what happens in a downside scenario, the difficulty is rarely presentational. It usually reflects genuine uncertainty in the credit itself.

Real estate lending and the value question

In real estate credit, loan-to-value is the most commonly cited measure and one of the most easily misread. A leverage figure means little without knowing which value it refers to: current value in the asset's present condition, value on completion of a business plan, or value assuming a stabilised income that has not yet been achieved.

Development lending adds a further layer, since the cost to complete is itself a variable. Construction costs, programme delays and contractor performance all influence whether an asset reaches the condition on which the lending was originally based. Assessing whether a project can be finished, and what it would take to finish it if the borrower could not, is a central part of the work rather than a contingency to consider later.

Underwriting does not end at drawdown

Once funds are advanced, the lender's position is largely fixed while the borrower's circumstances continue to change. Monitoring is therefore an extension of underwriting rather than an administrative task that follows it.

Regular financial information, site visits where relevant, and ongoing dialogue with the borrower all serve the same purpose: identifying deterioration early enough to respond to it. Problems in credit rarely appear without warning. More often there are indications well in advance, in delayed reporting, slower leasing, rising costs or increasing reliance on optimistic assumptions.

Preparing for the situation that does not go to plan

Some loans will underperform. The question is not whether this happens, but whether the lender is positioned to manage it when it does.

That position is established at the outset, through documentation, security and the relative strength of the lender's rights. It also depends on jurisdiction, since enforcement timelines, court processes and creditor protections differ considerably between countries, and a structure that works well in one market may be materially slower or more uncertain in another. These differences should inform underwriting rather than come as a surprise afterwards.

In many cases the better outcome is a negotiated solution rather than enforcement, but that too depends on having credible alternatives. A lender with limited rights has limited influence over the conversation.

Pricing, selection and the decision to decline

Private credit is ultimately a selection business. Not every transaction that can be completed should be, and a loan may be declined not because it is unsound, but because the return does not adequately reflect the risk, the structure offers insufficient protection or the repayment assumptions depend too heavily on conditions outside anyone's control.

Deal processes can create pressure to proceed, particularly where time has been invested and expectations have been set. None of that improves the credit. Declining transactions that do not meet a consistent standard is not an absence of activity; it is the mechanism through which a portfolio maintains its quality.

The return that matters

In credit, performance is measured less by the yield achieved on individual loans than by capital preserved across a portfolio over time. A strategy that consistently avoids permanent loss will usually outperform one that reaches for incremental return and occasionally suffers for it.

That outcome depends on the disciplines applied before capital is committed: understanding how a loan is repaid, structuring for the circumstances in which it is not, and remaining willing to decline transactions that do not justify the risk. In lending, the work done in advance is what determines whether the contractual return is ever actually received.

This article is provided for general information purposes only and does not constitute investment, legal, tax or financial advice, or an offer or solicitation to buy or sell any investment.