Bank-Level Lessons for Private Credit Valuations

By John Sedunov and Michael Pagano

Risk management has long been considered the domain of large, publicly traded banks – an exercise in regulatory compliance and systemic stability. Frameworks for measuring interest rate risk, credit exposure, and liquidity have historically been designed with institutions like JP Morgan or Bank of America in mind. Yet, the principles behind these frameworks are fundamental to valuation itself and increasingly relevant for private market vehicles that now perform similar intermediation functions. Historically, public markets have had robust frameworks for valuing risk – interest rate sensitivity, credit exposure, liquidity stress testing – because transparency and regulation demanded it.  Private markets, by contrast, relied on illiquidity premiums and long-term assumptions. But as private markets adopt semi-liquid structures, tokenization, and retail access, they too inherit public market-like risks:

• Continuous pricing pressure (due to tokenization and secondary liquidity).

• Regulatory scrutiny (as retail participation grows)

• Liquidity mismatch (similar to banks facing depositor runs).

This greater convergence means valuation models must integrate risk factors traditionally reserved for public markets – because private assets are increasingly behaving like public ones. 

Implications for Valuation

When private funds offer semi-liquid or tokenized products, NAV is no longer a static quarterly figure but rather influenced by interest rate volatility (affecting borrower solvency and loan values), credit deterioration (extend-and-pretend strategies mask true risk), and liquidity shocks (investor redemption pressure in semi-liquid structures). These risks mirror those priced daily in public markets. Applying bank-grade risk frameworks – like those we describe below – to private funds ensures valuations reflect both reality and contractual terms. 

For investors, this convergence creates an opportunity: those who adopt integrated risk-valuation models early will price private assets more accurately, manage liquidity better, and avoid missteps as regulatory and market norms tighten. In short, the same rigor that drives public market resilience is becoming a competitive edge in private markets.  A move away from siloed risk measurement and toward an integrated valuation framework will allow investors and managers to better understand how risk management impacts the value of their firms.[1] 

Private credit funds, business development companies (BDCs), hedge funds, and other alternative investment managers are increasingly engaging in intermediation functions that were previously exclusive to commercial banks.  Just as a bank's equity valuation depends on its exposure to credit and interest rate risk, so is the NAV (Net Asset Value) of these non-banks that are fulfilling the same function as commercial banks but potentially without the same level of scrutiny from regulators or public market participants.

As it relates to private credit especially, another CAIA blog post recently characterized private credit as entering its "Second Act," in which previously easier and lower-volatility returns are shifting toward a more complicated future.  This market has increased from around $310 billion in private corporate loans in 2010 to $1.7 trillion by the end of 2024.  Moreover, a 2024 projection shows that the private credit space will continue to grow, with a potential total addressable market of $30 trillion, as the opportunity set for private credit funds continues to grow.  This is especially true given the shift from direct lending to asset-based lending.   Thus, the private credit space has grown and will continue to grow.  It is no longer a niche space but has the potential to be systemic in nature and wide-ranging in its impact.  Thus, it is important for fund managers and investors to consider risk management as a key component of the valuation of these vehicles, and valuation techniques for these vehicles should be as robust as those that would be used for a typical commercial bank. 

Accordingly, we highlight here three of the biggest risks that both banks and private credit face, and how we can think about incorporating risk management practices into valuing private credit funds.  First, like commercial banks, private credit funds are exposed to interest rate risk, but with some nuanced differences.  Whereas banks face difficulties when rates rise if their assets are fixed-rate (and create an asset-liability duration mismatch), private credit loans are more typically made with floating rates.  This can allow the interest that the fund receives on its assets to float alongside the interest that it pays on its liabilities.  However, while this practice protects the lender's valuation from rate hikes, it transfers some risk to the borrower.  At some point, rates might become so high that it is prohibitively expensive for a borrower to pay their loans back in full.  

A valuation model can assess the point at which higher rates reach the point at which borrowers cannot pay, which effectively decreases the market value of the fund’s loan portfolio. For example, in our book, we tie together a financial organization’s risk management choices to the firm’s market value through a helpful mnemonic, “MRT,” which stands for the Magnitude, Riskiness, and Timing of cash flows. We also note that a firm’s or fund manager’s choices can be summarized as the “ART” of risk management, where one must decide to either Accept, Remove, or Transfer interest rate risk and other risks to maximize value for their investors. Risk management impacts value because the Magnitude, Riskiness, and Timing of the entity’s cash flows are directly affected by a manager’s choice to either leave a risk unhedged (Accept the risk), diversify it away through low / uncorrelated assets (Remove), or hedge it via derivative transactions or insurance (Transfer).   

Credit risk is a second area of overlapping risk.  An increasing trend among private credit lenders with their loans is to “extend-and-pretend.” This practice is increasingly important as interest coverage ratios for borrowers in the private credit space have dropped from 3.0x in 2020 to 1.5x in 2025.  This presents a clear valuation challenge as it is difficult to assess the value of a loan that is performing well only because the lender has eased on the terms of the loan.  Thus, in assessing the market value of a private credit fund, credit risk hedging, like for a bank, should be accounted for.  In this circumstance especially, one should consider "pretend and extend" strategies in which default may be delayed and thus negatively impact the fund’s portfolio value in the long run.

Finally, like banks, private credit funds can face challenges related to liquidity risk.  Whereas banks face the potential for depositors to run (especially uninsured depositors like in the recent case of Silicon Valley Bank in March 2023), private credit funds can have lockups that force investors to commit capital for a given period.  This practice should reduce liquidity risks.  However, as private credit fund exposure is extended to retail investors and potentially insurers (who are often concerned with matching and managing investment durations), there will likely be an increased demand for liquidity in this space.  If and how a private credit fund manages its capability to provide liquidity is an important consideration that can also be included in a valuation assessment of a fund. 

This discussion has focused mostly on private credit funds.  However, there are also valuation challenges for insurance companies and hedge funds, as these vehicles are also making private loans as part of the increasing “shadow banking” system.   Insurance companies, as mentioned above, have a need to duration-match their assets to their long-term liabilities and may increase private lending to seek new sources for investment.  Hedge funds may seek distressed debt or private credit secondaries.  In both cases, assessing the interest rate, credit, and liquidity risk management of these vehicles is an important step in both fund management and investment. 

In total, risk management is important for all institutions from small community banks to large private credit funds.  Risk management is not something that belongs in a silo, but rather it should be considered as part of the whole company and its valuation.  In the alternative investment space, as private credit continues its growth (through all types of vehicles), it is perhaps more important now than it ever has been to capture how and to what extent risks are managed within an integrated valuation technique. 

About the Contributors

John Sedunov is a Professor of Finance at Villanova University’s School of Business. His research interests include financial institutions, financial crises, FinTech, and risk management. Professor Sedunov’s work has been published in outlets such as Management Science, the Journal of Financial Intermediation, the Journal of Financial Stability, the Journal of Banking and Finance, and the Journal of Financial Research. He currently serves as a banking subject editor for Emerging Markets Review, and an associate editor for the Financial Review, the Journal of Financial Research, and the Quarterly Journal of Finance. Professor Sedunov’s research and comments have been featured in a variety of media outlets, including The Wall Street Journal, Financial Times, USA Today, thestreet.com, cnbc.com, U.S. News & World Report, CNN, Kiplinger, Washington Post, Los Angeles Times, Pittsburgh Post-Gazette, San Francisco Chronicle, and Bankrate. In addition to research-oriented activities, Professor Sedunov teaches courses related to the risk management of financial institutions and alternative investments.  
 

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