Private Credit Due Diligence: How to Look Past the Yield

Key takeaways

• Private credit usually consists of privately negotiated loans that do not trade in a deep public secondary market.
• “Direct lending” is a major private-credit strategy, but private credit also includes asset-based finance, specialty finance, real-estate credit, opportunistic/distressed credit, and other structures.
• Many direct loans are floating rate. That can reduce conventional duration exposure while increasing borrowers’ debt-service burden when base rates rise.
• Senior secured does not mean loss-proof. Recovery depends on enterprise value, collateral, documentation, priority, and what happens during restructuring.
• Reported NAV volatility can understate economic volatility because private loans are valued through periodic marks and models rather than continuous trading.
• Payment-in-kind, or PIK, interest can increase reported income while producing no current cash from the borrower.
• Non-accruals, amendments, extensions, covenant changes, and borrower add-backs often tell more about credit quality than headline distribution yield.
• Fund-level leverage magnifies both income and losses and can create financing pressure during stress.
• Semi-liquid private-credit vehicles can restrict redemptions. The Federal Reserve reported increased redemption requests in some such vehicles in 2026, with managers often applying available caps.
• The right comparison is not private credit yield versus Treasury yield. It is net expected return after defaults, recoveries, fees, leverage cost, taxes, and liquidity cost versus other uses of capital.

What private credit actually is

Private credit is an umbrella term, not a single investment.

The Federal Reserve describes private credit broadly as debt-like, non-publicly traded financing provided by nonbank entities to businesses. A common form is direct lending: a lender or small group of lenders negotiates a loan directly with a borrower rather than distributing the debt broadly through a public bond or syndicated-loan market.

That distinction changes the investment process.

Public bonds generally have published offering documents, market quotations, observable trading, external ratings in many cases, and a broad investor base. A privately originated loan can be negotiated borrower by borrower. Terms may include custom covenants, collateral packages, amortization schedules, call protection, equity participation, pricing floors, and lender consent rights.

The flexibility can be valuable to both sides. Borrowers may receive speed, confidentiality, certainty of execution, or financing that would be difficult in public markets. Lenders may receive higher spreads and stronger negotiated protections.

But opacity and illiquidity are part of the bargain.

Swoopr’s first private-credit principle:

Every extra percentage point of yield must come from somewhere. Find the source before deciding whether it is attractive.

Private credit is not one risk bucket

An investor should identify the actual strategy before evaluating performance.

Major categories include:

Direct lending

Loans made primarily to operating companies, often middle-market borrowers. These may be first-lien, second-lien, unitranche, secured, or unsecured.

Asset-based finance

Credit supported by pools of receivables or assets such as equipment, consumer loans, royalties, inventory, aviation assets, or specialty collateral. Risk can depend more on asset performance and servicing than on one corporate borrower.

Real-estate credit

Commercial mortgages, bridge loans, construction loans, mezzanine debt, and other financing tied to real property.

Opportunistic and distressed credit

Strategies that lend to or purchase debt of companies experiencing dislocation, refinancing pressure, or restructuring.

Specialty finance

Niche lending businesses serving markets that banks may not address efficiently.

Venture debt

Loans to growth-stage companies, sometimes paired with warrants or other equity-linked economics.

A portfolio of first-lien loans to profitable companies is fundamentally different from a fund financing transitional real estate or distressed businesses. Calling both “private credit” tells you too little.

The Swoopr yield decomposition

When a fund advertises a distribution yield, break the return engine into components.

A simplified framework is:

Base interest rate
+ credit spread
+ illiquidity premium
+ origination / structuring economics
+ possible leverage benefit
− credit losses
− management and incentive fees
− fund financing cost
− other expenses
= investor return before tax and valuation changes

This decomposition prevents a common error: treating a 10% private-credit distribution as if it were automatically “4% better” than a 6% public-credit investment.

Maybe the additional return compensates for less liquidity. Maybe it comes from weaker borrowers. Maybe the fund uses leverage. Maybe a portion is PIK income. Maybe spreads were locked in during an unusually attractive vintage. Maybe fees consume much of the difference.

Yield without attribution is marketing, not analysis.

Start with the borrower, not the fund wrapper

A private-credit vehicle is ultimately a portfolio of borrower promises.

For corporate direct lending, investigate:

• revenue durability;
• profitability and free cash flow;
• leverage ratios;
• interest coverage;
• cyclicality;
• customer concentration;
• sponsor ownership;
• recurring versus transactional revenue;
• capital expenditure needs;
• maturity schedule;
• ability to refinance;
• reliance on acquisitions;
• vulnerability to technology or regulatory change.

The Federal Reserve has highlighted interest coverage as a key risk metric in private credit. Floating-rate loans can protect lender income from rising base rates, but the borrower pays that higher coupon. What reduces duration risk for the lender can increase default risk for the borrower.

That is an important two-sided relationship.

Floating rate transfers some interest-rate risk into credit risk.

An investor should therefore ask how borrowers would perform if rates remain higher for longer, revenue declines, or refinancing markets become less accommodating.

Senior secured is a position in a waterfall, not a guarantee

“First lien” sounds reassuring. It should be understood precisely.

Seniority determines the order of claims. Collateral can improve recovery. Neither assures full repayment.

If a borrower’s enterprise value collapses, even senior secured creditors can take losses. Recovery can also depend on:

• quality and enforceability of collateral;
• competing liens;
• revolving credit facilities with priority rights;
• documentation;
• jurisdiction;
• restructuring cost;
• time to resolution;
• sponsor willingness to contribute new equity;
• whether reported EBITDA accurately represents cash-generation capacity.

Ask the manager for realized recovery experience, not merely default rates.

A lender that reports few defaults but repeatedly extends troubled loans may look healthier than a lender that recognizes losses promptly. Credit discipline is visible in workout behavior.

Covenants: protection only matters if it is usable

Private lending is often promoted as offering stronger covenants than broadly syndicated credit.

That can be true. But the word “covenant” is not enough.

Understand:

• maintenance versus incurrence covenants;
• leverage tests;
• interest-coverage tests;
• minimum-liquidity requirements;
• restricted-payment provisions;
• limitations on additional debt;
• collateral protections;
• EBITDA adjustment definitions;
• equity cure rights;
• baskets and exceptions;
• lender amendment rights.

A covenant with generous add-backs or broad exceptions can offer less protection than the label suggests.

Also ask what happens after a covenant breach. Lenders may waive, amend, reprice, receive fees, demand equity, add collateral, or restructure. A breach can create negotiating leverage, but it does not automatically generate a profitable outcome.

Watch EBITDA add-backs

Credit analysis frequently depends on leverage calculated against EBITDA.

The danger is that “adjusted EBITDA” can contain assumptions about synergies, cost savings, acquisitions, or future performance.

If debt remains real while earnings are aspirational, reported leverage can look better than economic leverage.

A useful diligence practice is to request both:

1. the manager’s underwriting EBITDA; and
2. a more conservative cash-flow measure with questionable add-backs removed.

Then recalculate leverage and coverage.

Swoopr calls this the cash reality test:

If the borrower had to service its debt from cash generated today rather than adjustments expected tomorrow, how comfortable would the capital structure look?

Understand PIK before counting it as income

Payment-in-kind interest allows interest to be added to principal rather than paid currently in cash.

PIK is not automatically problematic. It can be a negotiated feature of a growth investment or restructuring.

But rising PIK across a portfolio can signal that borrowers are conserving cash because they cannot comfortably service debt.

For each fund, ask:

• what percentage of investment income is cash versus PIK;
• how that has changed over time;
• whether PIK loans are concentrated in stressed borrowers;
• how frequently PIK ultimately converts into cash;
• what losses have occurred on PIK-heavy credits.

A dollar of accrued PIK and a dollar of collected interest are not economically identical.

Non-accruals are necessary but incomplete

When a lender stops recognizing interest on a troubled loan, the investment may be classified as non-accrual.

Investors often look at the percentage of portfolio value on non-accrual. That is useful, but incomplete.

Also examine:

• loans rated internally below plan;
• loans receiving repeated amendments;
• maturity extensions;
• covenant waivers;
• increases in PIK;
• fair-value markdowns;
• sponsor equity cures;
• loans transferred into workout categories;
• realized losses and recoveries.

Credit deterioration exists on a spectrum before formal non-accrual.

A manager’s internal risk-rating migration can be more informative than one end-state statistic.

Valuation: smooth does not mean safe

Private loans usually do not trade continuously.

Funds therefore estimate fair value using transaction data, comparable credits, discounted cash-flow models, third-party valuation firms, broker indications, and manager judgment.

This creates a fundamental difference from public markets.

A publicly traded high-yield bond can fall sharply in price today. A similar private loan may be marked down gradually over several quarters.

The second asset has not necessarily experienced less economic volatility. It may simply have less observable price discovery.

Ask:

• how often each investment is valued;
• how independent valuation firms are used;
• what proportion of assets are model-valued;
• how marks compare with eventual exit prices;
• whether manager valuations tend to lag public-credit moves;
• who governs valuation conflicts.

Do not compare reported Sharpe ratios across public and private assets without adjusting for valuation smoothing.

Fund leverage adds another balance sheet

Private-credit funds may borrow to increase assets and shareholder returns.

Leverage can work when asset yields exceed borrowing costs. It can also magnify credit losses and make liquidity management harder.

Separate:

borrower leverage from fund leverage.

A loan may sit at the top of a borrower’s capital structure while the fund itself has borrowed money to own it. The shareholder is exposed to both balance sheets.

Questions:

• debt-to-equity at fund level;
• type of financing facilities;
• fixed versus floating financing costs;
• maturity schedule;
• collateral requirements;
• asset-coverage rules;
• covenants;
• unused capacity;
• stress behavior if marks decline.

When leverage is part of the return engine, it belongs in every performance comparison.

Liquidity is vehicle-specific

Private credit can be accessed through different structures:

• institutional drawdown funds;
• listed business development companies;
• non-traded perpetual BDCs;
• interval funds;
• tender-offer funds;
• other registered or private vehicles.

Each creates a different liquidity contract.

A listed BDC may trade every market day, but at a price above or below NAV. An interval fund may offer periodic NAV-based repurchases subject to a percentage cap and proration. A private drawdown fund may lock capital for years.

The Federal Reserve’s May 2026 Financial Stability Report provides a timely lesson: some semi-liquid private-credit vehicles experienced higher redemption requests, and managers often used available redemption caps. The report described the requests as manageable at that time, but the episode demonstrates that limited-liquidity features can become economically relevant during changing sentiment.

Read the exact liquidity rules, not a brochure’s shorthand.

Vintage matters

Credit underwriting happens in markets that change.

A 2020 loan originated with low base rates, aggressive enterprise-value assumptions, and loose terms is different from a 2023 loan originated after rates increased and lenders gained negotiating power.

Assess:

• year of origination;
• base-rate environment;
• purchase multiples;
• lender competition;
• covenant quality;
• spread level;
• refinancing conditions;
• sector concentrations.

A fund’s historical return can be dominated by vintages that may not resemble the current opportunity set.

Do not extrapolate a manager’s past distribution rate without understanding when and how the portfolio was built.

Competition can erode future returns

Private credit has grown rapidly.

The Federal Reserve has noted that the industry’s growth and available capital can increase competition for deals. If too much capital chases a limited number of qualified borrowers, lenders may accept lower spreads, weaker structures, or more borrower-friendly terms.

That introduces a paradox:

An asset class can become more popular precisely when its future excess return becomes harder to earn.

Ask managers how underwriting standards change when spreads tighten. A disciplined lender should be able to explain deals it refused, not only deals it completed.

Manager skill is underwriting plus workout capability

Private-credit performance depends heavily on manager execution.

The important skills are not simply sourcing loans. They include:

• underwriting;
• documentation;
• sector expertise;
• portfolio construction;
• monitoring;
• amendment negotiation;
• restructuring;
• collateral enforcement;
• sponsor relationships;
• recovery maximization.

A manager can look excellent during an expansion when few borrowers default. Credit skill becomes clearer when a company misses plan.

Request data across a full cycle where available:

• realized gross and net returns;
• defaults;
• non-accruals;
• realized losses;
• recoveries;
• PIK trends;
• amendments;
• dispersion by vintage;
• worst investments;
• results after fees and leverage.

The best diligence question may be:

Show me the loans that went wrong and what you did next.

Concentration hides behind large loan counts

A fund may own hundreds of loans and still be concentrated.

Concentration can exist by:

• sector;
• private-equity sponsor;
• geography;
• borrower size;
• software or healthcare exposure;
• loan vintage;
• interest-rate sensitivity;
• acquisition-dependent business models;
• recurring revenue assumptions;
• collateral type.

Count exposures by economic driver, not only borrower name.

Ten software companies dependent on enterprise IT budgets can behave like one large thematic position during stress.

Private-credit fees need an all-in calculation

Potential costs include:

• management fees;
• incentive fees;
• administrative expenses;
• acquired-fund fees;
• financing costs;
• origination economics retained by manager or vehicle;
• servicing fees;
• distribution/share-class expenses;
• redemption or repurchase fees in some structures.

Compare net asset-level economics, not only the stated management fee.

If a portfolio yields 11% gross and the shareholder receives 7% net before tax, understand every step between those numbers.

Distribution yield is not expected return

A recurring distribution can be psychologically persuasive because it feels bond-like.

But total return also reflects:

• NAV changes;
• realized credit losses;
• fee drag;
• leverage;
• return of capital;
• valuation adjustments.

A fund distributing 9% while NAV declines 4% has not produced a 9% economic return.

Always reconcile distributions with total return and NAV history.

Worked example: two 10% yields that are not equivalent

Imagine two private-credit funds each reports a 10% current distribution rate.

Fund A

• mostly first-lien loans;
• moderate borrower leverage;
• 1% PIK income;
• limited fund leverage;
• low non-accruals;
• conservative marks;
• 2% all-in expenses.

Fund B

• more second-lien/unitranche risk;
• higher borrower leverage;
• 15% of income from PIK;
• substantial fund leverage;
• increasing amendments;
• smoother model marks;
• 3.5% all-in expenses.

The same distribution rate does not represent the same expected return or risk.

Fund B may ultimately outperform. The point is that the headline number cannot tell you.

Swoopr’s diligence framework asks the investor to reconstruct the source quality of the yield.

A practical private-credit scorecard

1. Strategy clarity

Can you identify exactly what the fund lends against?

2. Borrower quality

What are median leverage and interest coverage? How have they changed?

3. Seniority and collateral

Where do loans sit in the capital structure?

4. Covenant strength

Are lender protections meaningful or easy to adjust around?

5. PIK

How much income is noncash?

6. Non-accrual and watchlist migration

What is deteriorating before formal default?

7. Valuation

How independent and timely are marks?

8. Fund leverage

How much extra balance-sheet risk exists?

9. Liquidity

What can the investor actually redeem, when, and under what cap?

10. Fees

What is the all-in drag between borrower coupon and shareholder return?

11. Vintage

When was the book originated and under what lending conditions?

12. Manager loss history

What happened to bad loans?

If several answers are unavailable, uncertainty should be treated as risk rather than ignored.

Where private credit can fit conceptually

Private credit may serve as an income-producing credit allocation for investors capable of accepting limited liquidity and complex underwriting risk.

It should not be automatically classified as:

• a cash substitute;
• a Treasury substitute;
• a low-volatility bond substitute;
• guaranteed income;
• portfolio diversification simply because prices are not quoted daily.

The role depends on the actual strategy, vehicle, investor horizon, and interaction with the rest of the portfolio.

A diversified portfolio already exposed to leveraged companies through high-yield bonds, BDCs, small-cap equities, or private equity may have more underlying economic overlap with private credit than category labels suggest.

Swoopr bottom line

Private credit deserves better analysis than “higher yield, less volatility.”

Its economics come from lending to borrowers who pay for customized, non-public financing. Investors can be compensated for supplying capital, accepting illiquidity, underwriting credit risk, and allowing managers discretion over valuation and workouts.

The same features can create losses.

Start with the loans. Decompose the yield. Inspect borrower leverage and interest coverage. Understand seniority, collateral and covenants. Separate cash interest from PIK. Track non-accruals and watchlist migration. Challenge valuations. Measure fund leverage. Read redemption terms. Calculate fees. Study bad vintages and bad loans.

Then decide whether the net expected return after all of those frictions belongs in the portfolio.

Private credit is not difficult because it is mysterious. It is difficult because several risks that public markets display separately, credit, liquidity, valuation, leverage and manager skill, are bundled into one product.

That bundle is what investors must price.

Primary and supporting sources

1. Federal Reserve Board, Private Credit: Characteristics and Risks (February 23, 2024)

https://www.federalreserve.gov/econres/notes/feds-notes/private-credit-characteristics-and-risks-20240223.html

1. Federal Reserve Board, Bank Lending to Private Credit: Size, Characteristics, and Financial Stability Implications (May 23, 2025)

https://www.federalreserve.gov/econres/notes/feds-notes/bank-lending-to-private-credit-size-characteristics-and-financial-stability-implications-20250523.html

1. Federal Reserve Board, Financial Stability Report: Funding Risks (May 2026)

https://www.federalreserve.gov/publications/2026-may-financial-stability-report-funding-risks.htm

1. Investor.gov, Investor Bulletin: Interval Funds

https://www.investor.gov/introduction-investing/general-resources/news-alerts/alerts-bulletins/investor-bulletins/investor-bulletin-interval-funds

1. Investor.gov, Private Placements under Regulation D: Updated Investor Bulletin

https://www.investor.gov/introduction-investing/general-resources/news-alerts/alerts-bulletins/investor-bulletins/private

1. SEC EDGAR, Fund filing risk disclosure example, direct lending risk

https://www.sec.gov/Archives/edgar/data/2042256/000110465925067016/tm2512846d8_424b3.htm

Editorial / compliance notes

• Do not imply private credit produces guaranteed yield, low volatility, or automatic diversification.
• Reverify Federal Reserve market-size figures before future dated updates.
• Any fund example should use current prospectus/SEC filing data and show the observation date.
• Do not convert this education into individualized allocation advice.
• Where specific tax treatment is discussed on future child pages, source directly to current IRS guidance.