Private credit is often discussed as a single asset class. In reality, managers operating under the same “private credit” label can pursue materially different strategies.
One manager may focus on senior secured loans to growing core middle market companies. Another may lend to larger, more leveraged businesses, invest in junior securities, allow higher PIK usage, or accept weaker documentation in exchange for higher stated yield.
On the surface, two portfolios may appear similar. Underneath, the risk profile can be very different.
For advisors evaluating private credit managers, the most effective diligence conversations often begin with five questions.
Before evaluating yield, advisors should understand the underlying portfolio.
Private credit risk starts with portfolio construction: borrower size, industry exposure, market segment, sponsor concentration, and the types of companies receiving capital. A portfolio focused on core middle market companies may carry a different risk profile than one concentrated in larger, more broadly syndicated transactions. Similarly, a portfolio diversified across durable, cash-flowing businesses may behave differently from one with heavier exposure to cyclical sectors.
High industry concentration, exposure to highly cyclical sectors, larger syndicated deals with limited lender control, or limited clarity around the underlying borrowers.
A disciplined manager should be able to demonstrate a strong track record of executing its strategy, explain why its target market segment remains attractive, and show how portfolio construction is designed to support consistent outcomes while managing concentration risk.
Not all private credit exposure offers the same level of downside protection.
First lien loans, second lien loans, mezzanine debt, and equity all carry different levels of risk. They differ in payment priority, collateral protection, control rights, and potential recovery if a borrower experiences stress.
When markets are healthy, many structures can look attractive. When performance weakens, seniority and collateral can matter significantly.
Elevated exposure to junior securities, unclear collateral coverage, weak control rights, or strategies that rely heavily on enterprise value growth to protect the lender.
A disciplined manager should clearly define where they sit in the capital structure and how that position supports capital preservation if borrower performance deteriorates.
Leverage is one of the clearest indicators of downside risk in private credit. It measures how much debt a borrower carries relative to earnings, typically expressed as a debt-to-EBITDA multiple.
Higher leverage can support acquisitions, expansion, or growth when conditions are favorable. It can also reduce financial flexibility if earnings weaken. Lower leverage generally gives borrowers more room to navigate slower growth, margin pressure, or temporary operating challenges.
PIK, or payment-in-kind interest, is another important signal. PIK allows a borrower to defer cash interest by adding interest to the loan balance. While this can preserve liquidity in the near term, it may also increase the amount owed over time and signal weaker cash-flow capacity.
Aggressive EBITDA adjustments, high borrower leverage, meaningful PIK usage, weak interest coverage, or yield that depends heavily on non-cash income.
A disciplined manager should be able to demonstrate that portfolio yield is supported by cash-paying borrowers with sustainable leverage, conservative EBITDA adjustments, and limited exposure to PIK.
The purpose of a loan can reveal a lot about risk.
Debt used to support acquisitions, operational expansion, capital investment, or organic growth may help strengthen enterprise value over time. By contrast, debt used primarily for dividend recapitalizations or private equity sponsor distributions can increase leverage without improving the borrower’s fundamentals.
This distinction matters because not all uses of debt improve a company’s ability to repay.
Debt used primarily for distributions, limited sponsor equity contribution, no clear deleveraging path, or transactions that increase leverage without improving the business.
A disciplined manager should be able to explain why the borrower is taking on debt, how the proceeds support the business, and how the company is expected to repay over time.
The real test of a private credit manager often comes after a loan is made.
Strong underwriting matters, but so does ongoing monitoring. Advisors should understand how frequently the manager receives financials, what covenants are in place, how much access the manager has to borrowers and sponsors, and what happens when a company begins to underperform.
Maintenance covenants can provide early warning signals before a payment default occurs. Frequent reporting and borrower & sponsor relationships may also give managers more time to address issues before they become more severe.
Covenant-lite structures, limited reporting, large lender groups, weak information rights, or no clear process for handling deteriorating credits.
A disciplined manager should have visibility, control rights, and a defined playbook for engaging with borrowers before performance issues become payment problems.
Private credit can play an important role in client portfolios, but manager selection matters.
Similar yields can be supported by very different portfolios. One manager may generate income through senior secured loans to cash-flowing borrowers with conservative structures. Another may rely more heavily on junior securities, PIK income, weaker protections, or less transparent borrower reporting.
As an advisor, you’re in a better position to assess downside protection and portfolio resilience when you understand and recognize what those differences are.
Each factor shared here provides a different lens through which you have the opportunity to evaluate risk for your client. Strong due diligence often comes down to understanding not only how a manager seeks to generate returns, but also how they intend to protect investor capital through changing market environments.
Considering incorporating private credit into your clients’ credit portfolios? We welcome a conversation. Please contact invest@pennantpark.com or the professionals listed below.
PennantPark was founded in 2007 as an independent middle market credit platform. The firm was founded by Art Penn, a private credit industry veteran that previously co-founded Apollo Investment Management. We have invested over $27 billion across multiple economic and credit cycles since inception, and we manage $10 billion in AUM today.[i] PennantPark serves a broad range of sophisticated investors with product offerings that include business development companies, private capital funds, joint ventures, and other specialized funds.
Our highly experienced team primarily invests in the core middle market, targeting companies with earnings of $10 million to $50 million. These mid-sized companies are often overlooked by banks and large investment managers, resulting in senior secured loans that generally feature higher yields, lower leverage, and stronger lender protections when compared to the upper middle market and broadly syndicated loans. We focus on five key industry verticals where we have the most expertise and experience. These industries include healthcare, government services, business services, consumer, and software & technology.
[i] Assets under management (“AUM”) is defined as the sum of gross asset values, unfunded commitments, joint ventures and undrawn available leverage for active funds as of 12/31/2025. Invested capital represents the cumulative sum of capital invested across the PennantPark platform since inception through 12/31/2025. Figures are rounded to the nearest billion.
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