Seeking clarity on secured vs non-secured debt in corporate direct lending
I always read online that private credit (direct lending) is typically in the form of senior secured loans, but I'm confused on why it's considered secured. Direct lending is separate from ABF which of course is secured by the borrower's assets (receivables, inventory, equipment, etc.), but in a traditional direct lending deal, isn't the debt usually just protected by covenants like max. leverage, min. liquidity, etc.? I'm not understanding where the security comes from / why most fund managers' websites refer to a "senior secured direct lending strategy" - wouldn't that just make it an asset-backed loan? Thanks in advance for the help!
In direct lending, the term "senior secured" refers to the fact that the loan is backed by a lien on the borrower's assets, giving the lender a claim on those assets in the event of default. This is distinct from unsecured debt, where the lender has no such claim and relies solely on the borrower's creditworthiness and covenants for protection.
Here's the breakdown:
Secured Nature of Direct Lending:
Covenants vs. Collateral:
Why It's Not Just an Asset-Backed Loan (ABL):
Why Fund Managers Emphasize "Senior Secured":
In summary, the "secured" in senior secured direct lending comes from the lien on the borrower's assets, even if it's not as narrowly defined as in asset-backed financing. This security, combined with covenants, makes direct lending an attractive risk-adjusted return strategy for private credit funds.
Sources: Overview of Leveraged Finance, Alternative Lenders & the End of Risk Taking for Banks - Opportunity or Risk?, Overview of Leveraged Finance, So you want to work in CRE Debt? Here are the options..., Private Debt/Direct Lending Exit Opps?
It's senior secured because you are typically the most senior debt and your debt is secured by all assets of the company (and a pledge of the equity). However, the assets of the company are not going to provide a significant recovery/coverage on your loans and you are making them based on an assessment of cash flows (and the enterprise value associated with them).
ABL typically is looking at specific assets and lending at an advance rate (i.e. 80% on A/R, 50% on inventory, etc).
If you applied those ratios to a typical LBO (varies dramatically by sector) then coverage is only ~10-40% of debt typically. Whereas for an ABL deal, there will be >100% asset coverage. You can lose money in an ABL if the actual liquidation values of the assets are substantially below what you underwrote, but its typically harder, thus ABL is generally cheaper. There are also some exotic ABL that will go up to ~100% (or sometimes a little higher) of asset value or will lend on something more illiquid like Intellectual Property/Brand Value, but then it becomes almost a hybrid analysis and you will think about the cash flow dynamics of the business too. Those ABL deals price wider and are typically only sought by companies that are in/entering/exiting distress and have low liquidity and limited other access to capital.
Got it thank you sir!
What AKBOS said.
It is less about your actual "collateral" position and more about your ranking among other creditors. Being in the senior position means you control the proceedings in the event of default and any lender holding the same security as you in junior position follows your lead. As AKBOS noted, by virtue of having a lien on the trading assets; an ABL lender is structurally superior since they, by design, can be liquidated and paid out in 90 days leaving you with whatever is left. If you're doing senior secured with the idea that you'll actually just go take possession of your collateral and hold a fire sale in the event of default... you're doing it wrong.
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