title: "The private credit stack" description: "Senior secured, unitranche, mezzanine, and the structural reasons why private lenders keep taking share from banks." sectionLabel: "Credit Stack" order: 3

Private credit is the fastest-growing asset class in private markets, now at roughly $2.5 trillion in AUM. Understanding it requires understanding the capital stack: the layered structure of debt and equity that funds a leveraged transaction.

The stack, top to bottom

Senior secured (first lien) sits at the top. It has first claim on the company's assets in a default scenario. Because of this priority, it offers the lowest yield but the highest recovery rate. A well-underwritten senior secured loan in a performing company is the closest thing in private markets to a fixed-income instrument.

Second lien is subordinated to first lien. In a default, second-lien holders get paid only after first-lien holders are made whole. The additional risk commands a higher yield (typically 200 to 400 basis points above first lien) but comes with materially lower recovery.

Unitranche is the innovation that reshaped private credit. A single private lender extends one facility that economically combines senior and subordinated debt at a blended rate, typically S+500 to 700 basis points. For the borrower, this means one credit agreement instead of two, faster closing (weeks rather than months), more flexibility on covenant negotiation, and confidentiality versus public syndication.

Mezzanine sits between debt and equity. It typically includes both a cash pay coupon and a payment-in-kind (PIK) component that compounds. Mezzanine lenders often receive equity warrants as additional compensation for the risk. Recovery in default is low.

Equity absorbs the first loss. Equity holders receive nothing until all debt tranches above them are made whole. This is the option-theoretic insight covered in the Merton model: equity is a call option on firm assets, struck at the face value of total debt.

Contractual vs structural subordination

Two types of subordination exist, and confusing them is a common mistake.

Contractual subordination means the loan agreement specifies a payment waterfall. Second-lien lenders contractually agree to let first-lien lenders get paid first. Both loans sit at the same legal entity.

Structural subordination means debt sits at different levels of a corporate structure. A loan at the holding company level is structurally subordinated to a loan at the operating subsidiary level, because the subsidiary's creditors have direct claims on the subsidiary's assets. The holding company creditor must wait for value to flow up through the equity interest.

Why banks retreated

Basel III and its successor frameworks impose risk-weighted capital requirements on banks. Holding leveraged loans on a bank balance sheet now requires substantial capital reserves. For a bank, the return on equity of holding a $500 million leveraged loan is often unattractive relative to other uses of capital.

Private credit funds, structured as closed-end vehicles with committed LP capital and no regulatory capital requirements, can hold the same loans more efficiently. The LP capital is the cushion; the fund does not need to maintain regulatory reserves.

The Silicon Valley Bank collapse in 2023 accelerated this dynamic. Banks pulled back further from middle-market lending. The result: a borrower who ten years ago would have syndicated a leveraged loan through Goldman Sachs or JPMorgan now does a unitranche facility directly with a private credit fund.

The covenant advantage

Over 90% of syndicated leveraged loans (the bank market) are now "covenant-lite," meaning financial tests only trigger at specific events like a new debt issuance or an acquisition. The borrower can deteriorate significantly before any covenant triggers.

Private credit keeps maintenance covenants: quarterly tests on leverage ratios, interest coverage, and minimum liquidity. When a borrower begins trending toward trouble, the private lender sees it in the quarterly test and has the legal standing to renegotiate terms (re-price the loan, require an equity cure, or tighten operational restrictions) before the situation becomes a crisis.

This is the private credit lender's structural edge. The information advantage and covenant leverage allow for active portfolio management that the syndicated market cannot replicate.

Why this matters for the weekly issues

When The Private Markets Ledger reports on a private credit deal, the stack structure tells you the risk. A unitranche at S+550 on a 4.5x levered borrower is a very different risk profile from a second-lien at S+850 on a 6.0x levered borrower. When we report on redemption pressure (as in Issue №1), the underlying question is whether the loans in the fund's portfolio are positioned at the right level of the stack for the current credit cycle.