Steepe & Co. Field Guide to Private Credit Terms

Amortizing Loan:

A loan in which the principal is paid down over the life of the loan, typically through regular payments. Each payment consists of both interest and a portion of the principal.

Asset-Backed (Securities or Loans):

Financial securities whose value and income payments are derived from and collateralized (or “backed”) by a specified pool of underlying assets, such as loans, leases, credit card debt, or royalties. The pools of underlying assets can include common payments from credit cards, auto loans, and mortgage loans.

Asset-Based Lending:

A loan based on the assets of the borrower, where the loan amount is determined by the value of the collateral. Common assets used include accounts receivable, inventory, and equipment.

Asset Coverage Ratio:

A metric measuring the extent to which a company’s assets cover its outstanding debt. It’s calculated by dividing the company’s total assets minus certain liabilities by its total debt, offering insight into the firm’s financial health.

Blanket Lien:

A lien that gives the lender the right to seize, in the event of default, all assets used as collateral by a borrower. It provides broad protection to the lender.

Bridge Loan:

A short-term financing solution used by companies to cover expenses or new investments before longer-term financing can be secured. It acts as a “bridge” between liquidity gaps.

Bullet Loan:

A loan where the principal is not amortized over the term but is due in its entirety at the maturity date. Interest is usually paid periodically throughout the loan term.

Capitalization Rate (Cap Rate):

The rate of return on a real estate investment property based on the expected income it will generate. Calculated by dividing the property’s net operating income by its current market value.

Capital Call:

A request by an investment fund to its investors to transfer a portion of their committed capital. It’s used to cover expenses or to fund new investments.

Capital Stack:

The combination of all the different sources of financing a company utilizes, ranked by seniority. It includes equity, mezzanine debt, senior debt, and any other financing types.

Collateralized Loan Obligation (CLO):

A type of structured credit, where payments from multiple middle market corporate loans are pooled together and passed on to different classes of owners in various tranches. Each tranche offers a varying degree of risk and return, with senior tranches being paid out first, followed by mezzanine tranches, and equity tranches taking the most risk but potentially offering the highest returns.

Collateral Monitoring:

The continuous process of overseeing the value and condition of assets that secure a loan. Ensures that the value of collateral remains adequate relative to the outstanding loan amount.

Commitment Fee:

A fee charged by a lender to keep a line of credit open for a borrower. It’s usually calculated as a percentage of the unused portion of the credit facility.

Consumer Lending:

Direct loans provided to individuals for personal, family, or household purposes. Examples include personal loans, credit cards, and auto loans.

Corporate Credit:

Debt issued by companies to raise capital, typically in the form of bonds, loans, or lines of credit. It’s used for operations, expansions, refinancing, or other corporate initiatives.

Covenant:

Specific terms, conditions, or restrictions set forth in a loan agreement that the borrower must adhere to. Breaching a covenant can result in penalties or trigger a default.

Covenant-Lite (Cov-Lite) Loan:

A type of loan that has fewer covenants or protective clauses than traditional loans. It offers more flexibility to borrowers but carries higher risks for lenders.

Cross-collateralization:

A method where collateral for one loan is also used as collateral for another loan. If a borrower defaults on one debt, the lender has the right to seize assets used to secure any other debts the borrower has with that lender.

Default:

A failure to repay a loan as per the agreed-upon terms. This may trigger certain penalties or actions, as stipulated in the loan agreement.

Distressed Debt:

Debt of companies that are either in default, under bankruptcy protection, or in financial distress and heading towards such situations. Investors in distressed debt hope for recovery or improvement in the issuer’s situation to earn returns.

Direct Lending:

A situation where institutions or individual investors lend directly to borrowers without intermediaries, like banks or brokers. This method can offer higher returns and more direct control over terms.

Drawdown:

The process of transferring funds from a lending institution to a borrower. In private credit, it also refers to the capital that limited partners provide to the fund after a capital call.

Dry Powder:

Capital reserves kept on hand by investment firms, often private equity or venture capital entities, to cover future investments or unexpected liabilities. It indicates the amount of cash or cash-equivalent securities an entity has readily available.

Debt Service Coverage Ratio (DSCR):

A metric that measures the cash flow available to pay current debt obligations. It’s calculated by dividing the annual net operating income by the annual debt service.

Equity Kicker:

A type of financial arrangement in which a lender or investor receives equity in addition to regular loan repayments. This can be in the form of warrants or direct equity interests.

First Loss Position:

The initial portion of losses that will be taken by a specific tranche or class of securities before losses are realized by other classes. This position typically carries the highest risk and potential returns.

Grace Period:

The time period after a payment becomes due during which the borrower can make the payment without incurring penalties or additional fees.

Haircut:

A percentage that represents a reduction in the value of collateral assets below their market value. It provides a cushion for the lender in case the collateral needs to be liquidated.

Hold Period:

The duration of time an investment is expected to be held before it’s exited. It provides a timeframe for expected returns.

Insurance Lending:

Loans that are backed by insurance policies as collateral. It provides liquidity to policyholders or funds insurance companies’ operations.

Intercreditor Agreement:

An agreement between multiple creditors, stipulating the terms of their relationship, rights, and ranking when lending to a common borrower.

Interest Coverage Ratio (ICR):

A metric used to determine how easily a company can pay its interest expenses with its operating profit. It’s calculated by dividing the company’s EBITDA by its interest expenses.

Junior Debt:

Debt that has a lower priority in terms of repayment compared to other debt. It’s more risky than senior debt but usually offers a higher potential return.

Leveraged Buyout (LBO):

A transaction in which an investor acquires a company primarily using borrowed funds. The company’s assets or cash flows often serve as collateral for the loans.

Libor Floor:

A minimum interest rate threshold in loan agreements based on the London Interbank Offered Rate (LIBOR). Even if LIBOR falls below this floor, the interest on the loan will be calculated using the floor rate.

Lien:

A legal right or claim on assets used as collateral to secure a debt. In case of default, the lender can exercise the lien to recover the owed amount.

Litigation Finance:

The funding of legal cases by external parties in return for a share of the monetary judgment or settlement. It helps plaintiffs pursue a case when they might not have the necessary resources.

Liquidity Covenant:

A clause in a loan agreement that requires the borrower to maintain a specified level of liquidity or available capital. This ensures that the company can meet its short-term financial obligations.

Loan-to-Value (LTV) Ratio:

A ratio used to compare the amount of a loan to the value of the purchased asset, often used in mortgage lending. It helps lenders assess risk in the event of a default.

Lower Middle Market:

Companies with revenues typically ranging from $5 million to $50 million. These are smaller enterprises, often family-owned or closely-held.

Mezzanine Debt:

A hybrid form of capital that is subordinated to senior debt but senior to equity. It often comes with equity warrants or conversion features and carries higher interest rates due to its subordinate position.

Middle Market:

Companies with revenues generally ranging from $50 million to $500 million. These firms are larger than small businesses but not as vast as major corporations.

NAV Lending:

Loans based on the net asset value (NAV) of a borrower’s portfolio or assets. Common in private equity or hedge fund spaces, it provides liquidity against the fund’s underlying investments.

Negative Pledge Clause:

A covenant in a loan agreement that prohibits or restricts the borrower from using its assets as collateral for other loans. It aims to protect the lender’s interests by ensuring the borrower doesn’t dilute the value of the existing collateral.

Non-Amortizing Loan:

A loan where the principal doesn’t reduce over time since borrowers only pay the interest. The entire principal amount is paid back at the loan’s maturity.

Non-Performing Loan (NPL):

A loan where the borrower hasn’t made scheduled payments for a specified period, typically 90 days or more. NPLs are considered to be in default or close to being in default.

Non-Sponsored Deal:

A deal or transaction that doesn’t involve financial backing from an institutional investor or private equity firm. Instead, the company might rely on its internal resources, traditional bank financing, or other non-institutional means for the deal.

Opportunistic:

Refers to an investment strategy that seeks to capitalize on anomalies or inefficiencies in the market. Opportunistic investors are flexible and adapt their strategy based on current market conditions to achieve potentially higher returns.

Origination Fee:

A fee charged by lenders for processing a new loan. It compensates the lender for the work involved in vetting and creating the loan.

Pari Passu:

A Latin term meaning “on equal footing.” In finance, it refers to loans, bonds, or classes of shares that have equal rights of payment or rank equally in terms of seniority.

Payment in Kind (PIK):

A form of payment where the payer can pay interest or dividends with additional securities or equity instead of cash. Common in mezzanine financing, PIK increases the principal amount or number of securities outstanding.

Prepayment Penalty:

A fee charged by lenders when a borrower pays off a loan before its maturity date. It compensates the lender for the lost interest they would have received if the loan remained outstanding.

Private Credit Fund:

A specialized investment vehicle that provides private loans or debt to businesses, often bypassing traditional banking channels. These funds typically target mid-sized companies that need capital but might not have access to public debt markets.

Ratchet:

A mechanism in loan agreements that adjusts the interest rate based on the performance of the borrower, such as its leverage ratio or credit rating. It can either increase (upward ratchet) or decrease (downward ratchet) the interest rate.

Real Assets:

Physical or tangible assets that have intrinsic value due to their substance and properties, like real estate, commodities, or infrastructure. They often serve as a hedge against inflation and provide diversification in an investment portfolio.

Regulatory Capital Relief:

Financial instruments or strategies that help banks reduce their capital requirements as mandated by regulatory bodies. It aids banks in optimizing their balance sheets and enhancing return on equity.

Refinancing:

The process of replacing an existing loan with a new one, often with different terms or a different interest rate. Companies might refinance to take advantage of lower interest rates or to extend the maturity of existing debt

Revolving Credit Facility:

A type of credit agreement which allows the borrower to draw down, repay, and re-draw loans on a rolling basis. It offers flexibility in capital needs, similar to a credit card for businesses.

Royalties:

Payments made to the owner of a certain property, patent, copyrighted work, or franchise for the right to use their assets or intellectual property. It’s usually a percentage of gross or net revenues derived from the use of the asset.

Secondaries:

The buying and selling of pre-existing investor commitments to private equity and other alternative investment funds. Instead of investing directly in a company, secondary investors buy interests from existing stakeholders.

Second Lien Loan:

A type of loan that is subordinate to a senior or first lien loan in terms of repayment priority. If a borrower defaults, second lien lenders are repaid after the first lien lenders.

Secured Loan:

A loan that is backed by an asset or collateral, which the lender can seize if the borrower defaults. This type of loan generally offers lower interest rates due to decreased risk for the lender.

Securitization:

The process of transforming illiquid assets, like loans, into tradable securities. These securities are then sold to investors, allowing the original lender to free up capital.

Senior Debt:

Debt that has priority over other forms of debt in terms of repayment. If a borrower defaults, senior debt holders are paid before other creditors.

Senior Stretch Loan:

A hybrid loan combining elements of senior and subordinated debt. It bridges the gap between what senior lenders are willing to provide and what the borrower needs, offering a blended rate that’s usually lower than pure subordinated debt.

Special Situations:

Investment strategies centered on event-driven scenarios, like mergers, acquisitions, or financial distresses in companies. These situations can result in significant stock mispricing’s that opportunistic investors can exploit.

Specialty Finance:

Financial institutions or companies that provide specific types of lending or financing solutions not usually offered by traditional banks. Examples include invoice factoring, equipment leasing, or consumer finance companies.

Spread:

The difference between the interest rate charged to the borrower and the lender’s cost of funds or benchmark rate. It compensates the lender for taking on the risk of the loan.

Sponsored Deal:

A transaction, especially in private equity, where an institutional investor or private equity firm backs the deal or acquisition. This sponsorship provides the capital necessary for the transaction.

Structured Credit:

A complex financial instrument derived from a pool of assets that have cash flow and uses multiple tranches with varying risk profiles. It allows for customized risk/return profiles, commonly seen in asset-backed securities and collateralized debt obligations.

Subordination:

An arrangement where a creditor is placed in a lower priority for the collection of repayments than other creditors. This usually occurs when a creditor lends a borrower a new debt, making existing debts or other financial obligations secondary or subordinate.

Syndicated Loan:

A loan provided by a group of lenders to a borrower. It’s structured, arranged, and administered by one or several commercial banks or investment banks known as arrangers.

Term Loan:

A loan with a fixed term or maturity date by which the borrower must repay the principal. Payments may be made monthly, quarterly, or as agreed upon, often consisting of both principal and interest.

Trade Finance:

Financing solutions that facilitate international and domestic trade by bridging the gap between a seller’s need to get paid and a buyer’s need to delay payment until goods are received. Common instruments include letters of credit, export credit, and factoring.

Tranche:

A segment or portion of a structured financing arrangement. In the context of syndicated loans or securities, different tranches might have different risk levels, interest rates, maturities, or other characteristics.

Underwriting:

The process lenders use to assess the creditworthiness of a potential borrower, determining the terms under which they would be willing to lend. It involves evaluating risks associated with the borrower and the loan’s terms.

Unitranche Financing:

A type of debt that combines senior and subordinated debt into a single loan with a blended interest rate. It simplifies the capital structure and can speed up the lending process but might come at a slightly higher cost.

Unsecured Loan:

A loan that is not backed by any collateral. The interest rates for these loans are typically higher because lenders take on more risk.

Upper Middle Market:

Companies with revenues typically ranging from $500 million to $1 billion. They are larger than traditional middle-market firms but not quite as expansive as large-cap enterprises.

Venture Debt:

A type of debt financing for early-stage, high-growth companies, typically supplementing equity venture capital. It provides startups with working capital without further diluting ownership.

Vintage Year:

The year in which the first influx of investment capital is delivered to a project or investment. In private credit, it can help investors measure the relative performance of different funds based on the year the fund started investing.

Warrant:

A derivative that gives the holder the right, but not the obligation, to purchase securities (usually equity) at a certain price within a certain time. Warrants are sometimes attached to loans or bonds as a sweetener to enhance the yield for lenders.

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Contact Michael Steepe at michael@steepeco.com for more information.

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