Private Debt: Credit, Cash Flow and Recovery
Private debt is lending negotiated outside broadly traded public debt markets. Assess whether the borrower can service the loan, what the lender can recover, and how the contract protects the claim. A floating coupon reduces some rate sensitivity but can increase borrower stress.
The key decisions, at a glance
| Concept | What to do | Watch for |
|---|---|---|
| Cash interest | Compare recurring borrower cash generation with debt service. | EBITDA is not free cash available for every obligation. |
| Seniority and security | Identify priority, collateral and competing claims. | Senior does not mean certain full recovery. |
| Floating rate | A reference-rate increase raises the reset coupon, subject to terms. | Less fixed-rate duration does not remove default risk. |
| Liquidity and valuation | Separate a reported mark from an executable sale price. | An unchanged valuation can lag deteriorating credit. |
1. Cash interest
Compare recurring borrower cash generation with debt service.
Watch for: EBITDA is not free cash available for every obligation.
2. Seniority and security
Identify priority, collateral and competing claims.
Watch for: Senior does not mean certain full recovery.
3. Floating rate
A reference-rate increase raises the reset coupon, subject to terms.
Watch for: Less fixed-rate duration does not remove default risk.
4. Liquidity and valuation
Separate a reported mark from an executable sale price.
Watch for: An unchanged valuation can lag deteriorating credit.
Original worked case
A higher coupon can weaken coverage
Given: A borrower has $50m of debt priced at a floating reference rate plus 5%. EBITDA is $8m. The reference rate rises from 3% to 5%; ignore floors, hedges and changes in debt.
01 Before the reset
Cash interest = $50m × 8% = $4m; EBITDA/interest = 2.00x.
02 After the reset
Cash interest = $50m × 10% = $5m; coverage = 1.60x.
03 Interpret
The lender earns a higher contractual coupon while the borrower has less coverage.
Answer and interpretation
Credit analysis must stress both rates and earnings. The 1.60x ratio is a simplified indicator, not a default probability or a contractual breach by itself.
× EBITDA / interest · scale 0 to 2
| Scenario | Value |
|---|---|
| Initial | 2 |
| Rate reset | 1.6 |
| Reset + EBITDA fall | 1.2 |
Illustrative scenarios, not a market trend or a default forecast.
Change one assumption
If EBITDA also falls to $6m, coverage falls to 1.20x. Check cash conversion, principal payments and the actual agreement next.
Independent teaching example with the stated assumptions. Not an official exam question, marking key or observed market trend.
Understand the method
Part 1
Identify the source of repayment before comparing yields
Cash-flow lending relies primarily on a borrower’s capacity to generate cash from operations. Asset-based lending places greater emphasis on eligible collateral and its realizable value. The distinction is analytical rather than absolute: cash-flow loans can be secured, and collateral-based loans still need reliable servicing and controls. Trace the actual repayment source instead of classifying risk from the product label.
A loan’s coupon can contain a reference rate, credit spread, floor and additional fees. Compare expected net return only after considering default, recovery, prepayment, servicing costs and the timing of cash receipts. A high stated yield may compensate for a weak borrower or an illiquid position. It is not an expected return that can simply be inserted into an asset-allocation model.
Part 2
Bridge reported earnings to available debt-service cash
EBITDA is a starting point rather than a bank balance. Subtract cash taxes, working-capital needs, maintenance investment and other recurring cash obligations to estimate resources available for debt service. Then compare those resources with cash interest and scheduled principal. A business with strong accounting earnings can face a funding shortfall when inventory rises or customers pay slowly.
Separate temporary timing effects from structural deterioration. A seasonal working-capital draw may reverse later, while persistently weak cash conversion can indicate that reported earnings overstate repayment capacity. Stress interest rates and operating cash flow together. Floating-rate loans can reduce some lender duration exposure while simultaneously increasing the borrower’s cash burden.
Part 3
Build a recovery waterfall instead of assuming collateral is enough
Seniority defines contractual priority, and security identifies assets supporting a claim. Neither guarantees a particular recovery percentage. Competing liens, enforcement costs, structural subordination, asset location and realization delays affect what is actually available. Analyse the specific borrower and collateral pool rather than applying a generic senior-loan recovery assumption without explanation.
A simplified waterfall first deducts the costs assumed in the case, then pays claims in the specified order. Recoveries are capped at each claim’s entitlement. Junior creditors receive value only after the senior layer is satisfied, unless the actual restructuring changes the outcome. Legal enforceability and insolvency procedures require jurisdiction-specific advice; the teaching arithmetic illustrates priority, not a legal opinion.
Part 4
Separate expected credit loss from the stress funding need
Probability of default multiplied by loss given default and exposure gives a simplified one-period expected loss. It is an average under stated assumptions, not the maximum loss. Correlated defaults, declining collateral and longer workout periods can produce a much worse portfolio outcome. Concentration in one sponsor, borrower sector or collateral type can make those risks move together.
Private credit also creates valuation and liquidity questions. A model mark can remain stable while the price obtainable in a forced sale falls. Payment-in-kind interest increases the balance owed without providing spendable cash today. Track cash-pay income separately from accrued income, and test whether the borrower can refinance or repay the larger obligation at maturity.
Credit analysis extends beyond one coverage ratio
Operating cash conversion
- Useful evidence
- Working capital and maintenance spending
- Failure mode
- EBITDA does not become cash
Maturity repayment
- Useful evidence
- Amortization and refinancing capacity
- Failure mode
- A bullet payment has no credible funding source
Collateral recovery
- Useful evidence
- Priority, eligibility and stressed realizable value
- Failure mode
- Book value overstates net sale proceeds
Income quality
- Useful evidence
- Cash-pay versus PIK receipts
- Failure mode
- Accrual income masks a funding shortfall
More worked practice
Original teaching cases. Use the stated assumptions; these are not official exam questions or marking keys.
Allocate proceeds through a simple recovery waterfall
Given: Realizable assets are $42m. Assume $2m of realization costs is paid first, then a $30m senior secured claim, then a $20m junior claim. Ignore other claims and interest.
- 1Net proceeds available to lenders are 42 - 2 = $40m.
- 2The senior claim receives $30m, a 100% recovery.
- 3The junior claim receives the remaining $10m, a 50% recovery.
Interpretation: Total lender loss is $10m and falls on the junior claim under these assumed priorities. If asset proceeds fall by another $15m, net proceeds become $25m and even the senior claim is impaired.
Check your understanding
Answer first, then open the explanation. These checks are original practice and do not generate an exam score.
1. Is a 4% default probability a 4% expected loss?
Only if loss given default is 100%, under the simplified one-period model. At 40% severity, expected loss is 1.6% of exposure.
2. Why can PIK interest flatter current income?
It is accrued rather than paid in cash. The larger maturity obligation may be harder to repay.
3. Does passing covenants prove a borrower is healthy?
No. Definitions, thresholds and testing dates may allow compliance while economic repayment capacity weakens.
Common questions
Are floating-rate loans safe when rates rise?
Not necessarily. Resetting coupons can raise borrower debt-service costs. Credit losses, spread changes and illiquidity can outweigh higher income.
Does collateral eliminate loss?
No. Recovery depends on enforceability, priority, collateral value, realization costs and timing. Those can worsen together in stress.
Sources and scope
The sources below establish their stated framework or subject context. Calculations and cases are our own teaching material; these sources do not endorse them or establish complete exam coverage.
- IMF: The Rise and Risks of Private Credit (2024), chapter 2
Borrower, leverage, valuation and liquidity risks in private credit. Historical research, not current market statistics.
- CAIA curriculum and study tools
Official curriculum, companions and required readings for the exam year. The current page now links to 2027 materials.
- CFA Institute: Investments in Private Capital (2026)
Private capital structures and company lifecycle context. Supporting concept reference, not a CAIA curriculum crosswalk.
- CAIA 2027 curriculum overview
Published topic categories and Emerging Topics reading titles for 2027. The overview is not the complete learning-objective list.
By MiloPrep editorial team. Updated 10 October 2026. Independent study notes, not affiliated with or endorsed by CAIA Association. How we prepare our content.
Notes
- * Study scope: Selected study concepts, not complete curriculum coverage. Match your sitting to the official exam-year materials; CAIA’s current resource page now links to 2027. ↩ Return to content