Latest / The High Net Worth Podcast with Fexingo: Wealth Management, Tax Strategy, and Affluent Finance / How Family Offices Manage Private Debt Directly
Transcript
- Lucas: If our money conversations have helped you think about a decision differently, consider supporting the show directly. It keeps these deep dives ad-free and helps us keep digging into the mechanics of wealth, not just the headlines. You can find us at buy me a coffee dot com slash fexingo. Luna: Yeah, that support really lets us take the time to unpack things like direct lending properly. Thanks for listening. Lucas: Let’s get into it. For years, the playbook for high net worth individuals and family offices regarding private credit was pretty binary: you either bought shares in a large private credit fund, or you stayed out entirely because the minimums were too high and the liquidity terms were too opaque. But as we look at the market right now in early October twenty twenty six, there is a distinct shift happening where sophisticated families are moving from being passive investors to becoming direct lenders. Luna: So they are skipping the middleman and originating the loans themselves? That sounds operationally heavy for what used to be a set-it-and-forget-it asset class. Lucas: It is heavier, but the economics make sense when you look at the spread. In a direct lending scenario, the family office acts as the bank. They provide the capital directly to a mid-market company—usually one with between five hundred million and two billion dollars in revenue—that needs working capital or wants to refinance existing debt without going through the public bond market. The key here is that these companies often pay a premium for speed and certainty of execution, which allows the lender to capture a yield that is significantly higher than what you get from a corporate bond ETF. Luna: But if they are acting as the bank, do they also take on the full risk of default? Because unlike a diversified fund, a direct loan is usually concentrated in one borrower. Lucas: That is the critical distinction. In a fund, you might have exposure to fifty different borrowers, so one failure doesn’t sink the ship. In a direct deal, you need rigorous underwriting. We are seeing families hire specialized credit analysts or partner with boutique advisory firms that focus solely on structuring these senior secured loans. The collateral package is everything. We are talking first-lien positions on tangible assets like inventory, receivables, and equipment. If the borrower defaults, the family office has the first claim on those assets. Luna: So it’s less about hoping the stock goes up and more about ensuring the collateral covers the principal even in a downside case. That feels much more aligned with how traditional wealth managers think about safety. Lucas: Exactly. And there is another layer to this that isn’t always obvious. These private debt deals are often illiquid by design. You aren’t selling them on an exchange every day. This actually works in your favor during times of market stress. When public credit markets freeze up—as we saw during certain banking crises in the last few years—these private loans continue to service their interest payments because the relationship is bilateral and ongoing. The borrower still needs cash flow to operate. Luna: I’m curious about the interest rate environment though. With rates having stabilized around these elevated levels, does that change the appeal for the borrower? Are they desperate enough to accept these private terms? Lucas: Actually, yes. The cost of public debt has risen, and many mid-market companies simply cannot access the public bonds market anymore because their credit ratings don’t justify the spreads they would have to offer. So they come to private lenders. The trade-off is that while the interest rate is higher—often floating based on SOFR plus a spread—the flexibility is better. There are fewer restrictive covenants than in a public bond indenture, and the maturity dates can be customized to match the company’s cash flow cycle rather than a rigid ten-year calendar. Luna: Customized maturities sound like a double-edged sword. If the company’s cash flow dips, they might struggle to repay, but if they do well, they aren’t locked into a long-term obligation they don’t need. Lucas: Right. And that customization is where the alpha comes from. A standard fund manager has to stick to generic terms to keep the product liquid and scalable. A family office can say, okay, we will extend the term by eighteen months if you agree to pay a slight premium in the final quarter. It is negotiation-based finance, which is something most individual investors never experience outside of buying a house. Luna: It feels like you are describing a very hands-on approach. How do most families actually execute this without building an entire internal credit department? Lucas: They use a hybrid model. The family provides the capital and sets the risk parameters—typically looking for investment-grade quality, even if the borrower is technically below that rating due to leverage. Then they engage a third-party servicer or originator to find the deals and manage the ongoing reporting. The family sits on the investment committee. They approve the deal structure, review the quarterly financials, and decide whether to renew or call the loan at maturity. It gives them control over the timing of their exit. Luna: So they retain the upside of the yield but offload some of the administrative burden. But what happens when the loan actually goes bad? Is there a clear protocol for restructuring versus liquidation? Lucas: In private credit, you have more tools than just foreclosure. Because you hold the debt, you often have board observer rights or even board seats. This gives you visibility into the company’s operations before things go wrong. You can renegotiate the terms, inject more capital as a bridge loan, or work with management to sell off non-core assets. It is a collaborative problem-solving process rather than an adversarial legal battle, which typically preserves more value for everyone involved. Luna: That collaboration aspect is interesting. It implies a level of trust and long-term relationship that you don’t get with anonymous bondholders. Does that relationship help mitigate moral hazard on the part of the borrower? Lucas: It absolutely does. When a company knows they have a private lender who understands their business model and isn’t going to sell the loan to a distressed debt hedge fund overnight, they are more likely to prioritize repayment. There is a reputational component to private debt. If you default on a private loan, you effectively close the door on future private financing, which is crucial for mid-market growth. Luna: So it’s almost like a community-based banking system but for larger corporations. High trust, high scrutiny, high yield. Lucas: That is a fair way to put it. And we are seeing this scale up. Ten years ago, maybe only the top percent of family offices could afford the due diligence costs to originate a single direct loan. Now, platforms exist that allow smaller pools of capital to participate in syndicated private loans. This means a family with fifty million dollars in investable assets can now allocate five million to a direct lending portfolio without needing a team of ten analysts. Luna: Syndicated loans still carry concentration risk, though. If the lead lender misses something, everyone gets burned. How do they protect against that in a group setting? Lucas: They rely on the lead arranger’s reputation and legal agreements. The syndicate agreement outlines exactly who is responsible for monitoring the borrower. Usually, the family office investor agrees to follow the lead lender’s decisions unless there is a material breach. It is a trade-off: you give up some control for access to larger, higher-quality deals that you couldn’t originate alone. Luna: It seems like the barrier to entry is lowering, but the complexity remains high. What is the biggest mistake families make when they first dip their toes into this space? Lucas: They underestimate the duration risk. In public bonds, if rates rise, the price drops, but you can sell. In private debt, you are locked in for three to seven years. If you need liquidity for a real estate purchase or a business acquisition in year two, you generally cannot exit that loan easily. Families often misallocate short-term cash into long-term debt structures, creating a mismatch that causes stress later. Luna: So liquidity planning becomes part of the underwriting process itself. You aren’t just assessing the borrower; you are assessing your own need for cash flow during that period. Lucas: Precisely. And that ties back to the broader macro environment. With inflation proving sticky and central banks maintaining higher policy rates, the opportunity cost of holding cash is high, but the risk of equities is also elevated. Private credit offers a middle ground: predictable income, lower volatility than stocks, and protection against equity drawdowns. It is becoming a core holding, not just a satellite play. Luna: I wonder if this trend pressures traditional banks further. If family offices and private funds are eating this lunch, do regional banks stop making these mid-market loans altogether? Lucas: Some are retreating from the lower end of the mid-market due to regulatory capital requirements, which makes private credit even more attractive. Banks prefer large, complex transactions or highly regulated consumer lending. They are leaving the SME and mid-market gap open, which private lenders are filling rapidly. It is a structural shift in the financial ecosystem, not just a cyclical one. Luna: Structural shifts tend to stick around. It feels like the definition of 'safe' is expanding beyond government bonds and blue-chip stocks. Lucas: It is. And for the affluent listener, understanding this mechanism is vital. It changes how you view your fixed income allocation. You are no longer just buying coupons from governments or corporations; you are potentially becoming the bank for the businesses that drive the local economy. Luna: There is a certain weight to that responsibility. Do you think the ethical implications of profiting directly from corporate debt will become a bigger conversation point for family offices? Lucas: It already is. Many family offices have ESG mandates. They are increasingly screening borrowers for environmental and social criteria. You might see a family office refuse to lend to a fossil fuel extractor, or conversely, actively seek out green bonds or sustainability-linked loans where the interest rate improves if the borrower meets certain carbon targets. It adds another layer of due diligence, but it aligns the investment with the family’s values. Luna: Values-driven lending. It’s nice to see finance connecting back to purpose rather than just pure arbitrage. Where do you see this heading in the next five years? Lucas: I think we will see more securitization of these private loans. Right now, most direct loans are held on balance sheets. Eventually, they will be packaged into securities and sold to institutional investors, bringing even more capital into the space. This will increase competition, which might compress yields slightly, but it will also improve liquidity for the original lenders. Luna: More liquidity means easier exits, which solves that duration risk problem Lucas mentioned earlier. It seems like the whole ecosystem is maturing rapidly. Lucas: It is. And for those considering it, the lesson is to start small. Don’t commit your entire fixed income book to direct lending immediately. Use a portion to learn the rhythm of the underwriting, understand the covenant packages, and see how you handle the psychological pressure of holding a single name. Once you are comfortable, then you scale. Luna: Practical advice. Test the water before diving in. Do you think the regulatory landscape will catch up to this quickly, or will it remain a gray area for family offices for a while? Lucas: Regulators are watching closely. The SEC and other bodies are concerned about systemic risk if too much credit moves into unregulated channels. We may see new reporting requirements for private credit funds, which could trickle down to how family offices structure their direct investments. But for now, the regulatory framework is still catching up to the innovation. Luna: Innovation outpacing regulation is a classic theme. It leaves room for early adopters to shape the standards. Lucas: Exactly. And that shapes the industry. If family offices demand transparency and fair treatment, the market adapts. It is a powerful lever for wealth holders who understand how the plumbing works. Luna: Well, understanding the plumbing is half the battle. The other half is deciding which pipes to connect. Thanks for breaking that down, Lucas. Lucas: Anytime. It is a complex space, but one that rewards patience and discipline. Let’s see how this evolves as we move through the rest of the year.