How does risk-based lending work in private credit and what returns does it target?

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AcadiFi · Accepted Answer

Risk-based lending in private credit prices loans based on borrower-specific credit risk, collateral, and structural protections rather than reference-rate benchmarks alone...

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At Ironbark's private credit allocation, a typical middle-market direct loan might be: $45M senior secured term loan to a $180M-revenue industrial distributor, SOFR + 625 bps, 5-year term, 1% upfront fee, 2% OID, covenants on leverage (below 4.5x EBITDA) and fixed-charge coverage (above 1.25x).

Structural features driving the risk-based return: (1) Floating rate with SOFR floor (typically 1%) protects against falling rates. (2) Call protection (non-call 1, 102/101 premium) preserves yield if refinanced early. (3) Maintenance covenants trigger lender negotiation rights on deterioration. (4) Collateral packages include accounts receivable, inventory, equipment, and equity pledges.

For AcadiFi Level III candidates: understand that private credit returns are illiquidity-premium-driven, not pure alpha. Compare vs broadly syndicated loans at SOFR + 350 bps. The extra 250-450 bps compensates for illiquidity, information asymmetry, and concentrated default risk. Also, manager skill shows in deal sourcing, credit underwriting, and workout capability — especially crucial in the bottom of the cycle when default rates rise from 1-2% to 5-8% in middle-market direct lending.

How does risk-based lending work in private credit and what returns does it target?

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