The private credit market has undergone rapid transformation, and one trend worth highlighting is the emergence of innovative financing structures. While borrowers on the margin have leaned toward the broadly syndicated loan (BSL) market this year, direct lending continues to gain traction, particularly among larger borrowers.

Direct Lending’s Growing Influence

Direct lenders have continued to increase in size because of strong investor demand for the asset class and consolidation in the industry, which has allowed lenders to write bigger and bigger checks. According to S&P data, year to date through the third quarter, the share of the largest borrowers in the credit-estimate universe, defined as borrowers with over $1 billion in debt, has increased to 9% from 6% in 2024 and just 2% in 2021.  The evolution and maturation of the private credit market, combined with its advantages of speed and certainty of execution and flexibility, have made it a more attractive option for larger borrowers. While S&P expects some ebb and flow between private and public markets, the trend toward larger borrowers tapping private credit is likely to persist.

Financial Engineering: A New Frontier

To fund ambitious investments, companies have been experimenting with more novel forms of debt.  Sometimes private loans look like those made by traditional lenders, but they have become more creative.  Apollo, a major private-markets firm, has devised a creative financing structure that benefits both borrowers and lenders by exploiting how capital is classified. The Fed has noted a shift in “portfolio allocations toward risky corporate debt, while exploiting loopholes stemming from rating agency methodologies and accounting standards.” This trend underscores the growing complexity of credit markets.

How it works:

• For Borrowers (Recipient of the loan):
  • The loan is structured so that rating agencies treat it as “equity” rather than debt.
  • Why does this matter?
    • This distinction matters because equity doesn’t inflate leverage ratios, allowing borrowers to preserve their credit ratings while still accessing financing.
• For Apollo (the Lender):
  • On Apollo’s balance sheet, the same transaction is recorded as investment-grade debt. This makes Apollo’s portfolio look safer and higher quality, even though the underlying deal is unconventional.

Why Is This Innovative?

• It’s a form of financial engineering that manipulates classification rules:
  • Borrowers avoid the stigma and cost of more debt.
  • Lenders get a strong-looking asset.
• This is part of a broader trend where companies are feasting on debt to fund massive projects (like AI data centers) but using increasingly opaque and complex structures to hide leverage.

These arrangements blur the line between debt and equity, making it harder for outsiders to assess true financial risk. If markets turn, such creative structures could amplify instability because real exposure is hidden. For credit professionals, vigilance is key: understanding the mechanics behind these deals will be critical to navigating a landscape where classification rules, rather than fundamentals, increasingly shape outcomes.