Private Debt: An Introduction

Since the global financial crisis (GFC), institutional investors have increasingly included private debt in their broader portfolios. Private debt refers to loans made to companies by nonbank lenders, like asset management firms, pension and insurance funds, hedge funds, or dedicated private capital funds. This note introduces the types of private debt and the drivers of its growth, describes its rise as a result of regulatory changes after the GFC that limit banks&apos; ability to lend, relates it to the concurrent rise of the private equity industry, and discusses its risks.In the University of Virginia Darden School of Business, this note is taught in the second-year elective, “Financial Institutions and Markets,” along with the case “Private Debt and a University&apos;s Endowment Portfolio Decision” (UVA-F-2108). It can also be used in a course on private capital, private markets, investments, asset management, or private wealth.<p>Excerpt</p><p>Private Debt: An Introduction</p><p>What Is Private Debt?</p><p>Private debt refers to loans made to companies by nonbank lenders, rather than traditional banks, public bond markets, or syndicated loan markets. Examples of nonbank lenders include asset management firms, pension and insurance funds, hedge funds, and dedicated private capital funds. Private debt has become an asset class that many institutional investors have included in their broader portfolios over time.</p><p>Types of Private Debt</p><p>Historically, there have been three main categories of private debt: direct lending, asset-based financing, and special situations.</p><p>Direct lending, which is the private-debt market&apos;s largest segment, involves nonbank institutions providing loans primarily to middle-market companies (those with $50 million to $500 million in revenue). Historically, these borrowers were too small for the public bond markets and were often overlooked by commercial banks that focused on lending money to larger companies. Direct-lending loans are typically floating-rate loans and senior in the capital structure. The interest rate paid to lenders is based on the Secured Overnight Funding Rate (SOFR) plus a credit spread to compensate for the risk of the loan.</p><p>. . .</p>