Covenant Lite #15: A Brief History of Private Credit

The Golden Age of Private Credit: A History in 10 Parts

Inspired by Will & Ariel Durant's The Lessons of History—which summarizes 5,000 years of history in ~100 pages—I wanted to revisit the first post I ever wrote, Covenant Lite #1: A History of Private Credit (Link), in an abbreviated form. It’s the foundation of this Substack, and many new readers haven’t seen it yet.

So here's the history of private credit, retold in a tighter, punchier format—with just enough context to keep you smart at dinner.

1. It All Started in a Mud Hut Bank

Long before spreadsheets and leveraged loans, lending was already old news. As far back as 3,000 BCE in Mesopotamia, people were borrowing grain from temples and tracking IOUs on clay tablets. This wasn’t a side hustle—these early institutions were proto-banks.

As society advanced, banks (and banking as an institution) became more established and influential. By the Middle Ages, prominent banking families like the Medicis and Rothschilds wielded outsized influence by lending to popes and kings for their wars and artistic movements.

Further innovation in city centers like London and Amsterdam saw the establishment of capital markets, which enabled (mostly) large companies to tap non-bank sources of capital from institutions such as insurance companies and asset managers. But even as public bond markets emerged for the biggest players, small- and mid-sized businesses still relied on local bankers.

2. Enter Milken, The Junk Bond Jedi

In the 1970s, a young financier named Michael Milken was doing some contrarian thinking from a cubicle in Los Angeles. At the time, Wall Street ignored any company without a pristine credit rating. Investment grade or bust.

Milken, working at Drexel Burnham Lambert, noticed something odd: many companies that had been downgraded from investment grade to "junk" weren’t failing. They were simply misunderstood—and a portfolio of these bonds, which he rebranded as “high yield” rather than junk, actually outperformed their investment grade brethren.

Drexel became a high yield bond juggernaut, matching companies formerly thought of as “unbankable” (because they had been recently downgraded—or because they were too small) with willing capital from his network of insurance companies and asset managers that he had cultivated. He didn’t just build a trading desk—he built a movement.

From his LA perch (far from the scrutiny of Wall Street), Milken created demand for these bonds by educating institutional investors, underwriting deals, and showing the math. His efforts helped channel billions into companies that banks had long ignored. Eventually, he got rich (very rich), and then got into legal trouble. But his core idea reshaped finance: there’s a whole world of worth borrowers that traditional finance ignores.

3. Regulators (Unwittingly) Build Private Credit

While Milken was rewriting the rules of access, the regulators were busy tightening the screws on banks. In the aftermath of financial turmoil in the 1970s and 1980s—think the oil shocks, inflation spikes, and the Latin American debt crisis—global policymakers decided the banking system needed more guardrails. Regulators weren’t looking to spark innovation; they were trying to prevent disaster. But in doing so, they accidentally created the conditions for private credit to flourish.

Basel I, introduced in 1988, was the first global agreement to standardize how much capital banks had to hold relative to the riskiness of their assets. Lending to a big, stable company? That was fine. Lending to a scrappy, leveraged middle-market business? Suddenly a capital-intensive problem. Banks could no longer justify the risk-return tradeoff for smaller borrowers—and so increasingly focused on lending to larger, more established companies.

Then came the Highly Leveraged Transaction (HLT) guidelines, which effectively discouraged banks from making loans with leverage ratios over 6x EBITDA. The private equity-led LBOs of the 80s—financed in part by junk bonds—were now a less attractive lending proposition for banks. Banks pivoted to providing the safer tranche of capital: typically first lien loans at a <4x EBITDA detachment point, leaving further leverage (otherwise known as mezzanine debt, explained below) to other sources of capital.

4. 1990s-2000s: Birth of the Private Credit Mafia

Drexel Burnham Lambert collapsed in 1990 under the weight of scandal and regulatory pressure, taking down Michael Milken's empire with it. But from those ashes rose something new: a generation of former Drexel bankers who understood the power of non-bank credit—and weren’t eager to join a traditional bank.

Instead, they went off on their own. Apollo, Ares, Oaktree, Cerberus, and others were all born from Drexel alumni who had seen firsthand how capital could flow outside the confines of the traditional banking system.

These firms didn’t start with massive direct lending machines. They started with mezzanine debt—the in-between layer that sat above senior bank loans and below equity. Why? Because banks wouldn’t touch it. Basel rules made mezz capital too risky to hold, and yet it was essential for buyouts and growth plans. It paid well, offered equity-like upside through warrants, and—importantly—let sponsors avoid diluting their equity.

So that’s where private credit began in earnest: not with giant first-lien loans, but with bespoke mezz solutions, priced expensively and executed quickly. It was a niche—but a lucrative one.

5. 2008 Crisis: Banks Bail, Credit Funds Prevail

The Great Financial Crisis was supposed to be the moment for traditional finance to regroup. Instead, it was private credit’s breakout act. Basel III and Dodd-Frank further constrained banks, making it even harder (and more expensive) for them to lend to anyone remotely risky.

Meanwhile, credit funds were flush with institutional capital and ready to step in. As banks retreated, private lenders became the preferred—and often only—source of capital for middle market borrowers.

6. 2010s: The Private Equity Flywheel

Private equity firms had a problem: they needed debt to fuel returns, but banks were increasingly constrained from providing capital at the leverage levels PE needed. Enter private credit. The alignment was perfect. PE firms needed certainty and speed; credit funds offered just that.

From 2009 to 2024, PE AUM tripled, and private credit AUM grew 5x. This wasn’t a coincidence. They grew together. With banks kneecapped by regulators, private credit could now compete on first lien loans (in addition to the mezzanine debt that used to be their remit). First lien direct lending became the new normal, replacing banks entirely for many deals. Flexibility beat price. Execution beat process.

7. Why Go Public?

Remember when an IPO was the dream? Today, it’s more of a burden. With deep pools of private debt and equity, companies can grow, scale, and even exit without touching public markets. SpaceX, ByteDance, OpenAI—all are multi-billion dollar private giants. In fact, the number of public companies in the U.S. has dropped 40% since the '90s. Companies are increasingly questioning the wisdom of going public. Why go public when private capital is just easier and faster?

8. Today: $1.6 Trillion and Climbing

Private credit is now on par with the leveraged loan and high yield bond markets in terms of AUM. BlackRock thinks we’ll hit $3.5 trillion by 2028. The opportunity is massive, and the jockeying is fierce. Funds are scaling, innovating, and fighting for market share.

9. What’s Next? 3 Big Trends

1. Investment Grade Private Credit Apollo and others are pioneering IG private credit—bringing faster execution and lower fees to big issuers, and a juicy spread for insurers.

2. Bank Partnerships Big banks like Citi and JPM are outsourcing origination to credit funds. They want fees, not balance sheet risk. Win-win.

3. Asset-Based Lending From receivables to planes to IP royalties—asset-based lending is heating up. Less tied to EBITDA, more tied to things you can repossess.

10. What This Substack Covers

Private credit is way more than direct lending. Here, we’ll dive into its strangest, smartest corners: litigation finance, music royalties, trade finance, tax credits, equipment leasing, and more. Expect deep dives, spicy takes, and no boring jargon.

☞ If you learned something (or just enjoyed the ride), forward this to a friend who still thinks private credit is just a fancy name for loan sharks.

Until next time, Covenant Lite