Quality-First Private Credit Screen
Filter borrowers for resilience before underwriting returns
- Difficulty
- Advanced
- Time to result
- ~months to results
- Steps
- 6
- Confidence
- 98%
The screen begins with business quality rather than the headline yield. A lender first looks for a meaningful middle-market company that leads its niche, produces recurring cash flow, and has demonstrated durable growth. It then removes businesses whose outcomes depend heavily on volatile consumer demand, thin margins, or unpredictable commodity prices. Management quality, private-equity sponsorship, capitalization, leverage, and covenants provide additional layers of protection. Finally, the lender stress-tests whether cash flow can service debt when base rates rise or operating conditions weaken. The output is a smaller pool of resilient borrowers whose underlying economics, rather than optimistic projections, support repayment. This approach may sacrifice some high-yield opportunities, but it seeks stronger risk-adjusted returns and fewer defaults across market cycles.
Origin
Ken Kencel described the underwriting approach Churchill Asset Management used to keep its portfolio resilient through the global financial crisis, COVID, and rising interest rates.
Core principles
- 01Prefer durable cash flow over speculative revenue
- 02Back market leaders with demonstrated growth
- 03Avoid risks dominated by commodity prices or volatility
- 04Require meaningful equity beneath the debt
- 05Treat covenants and conservative leverage as downside protection
How to run it
- 1
Screen for market leadership
Establish whether the company is a leading player in a defensible niche and large enough to withstand disruption.
Pro tip Look for a number-one or number-two position in a clearly defined market.
Watch out Do not mistake a narrow product claim for genuine market leadership.
- 2
Validate durable cash flow
Confirm that revenue converts into established cash flow and is supported by recurring or embedded customer relationships.
Pro tip Favor essential software, information services, healthcare, logistics, and similar durable services.
Watch out Do not underwrite venture-style revenue as though it were dependable cash flow.
- 3
Remove external volatility
Reject businesses whose repayment capacity can be overwhelmed by commodities, thin margins, or unstable demand.
Pro tip Ask whether correct company analysis could still be defeated by an unrelated market price.
Watch out A good operator cannot always overcome a collapsing commodity or structurally fragile industry.
- 4
Assess people and sponsorship
Evaluate management and the private-equity sponsor's record, industry expertise, and behavior in previous deals.
Pro tip Use prior transactions and fund-level relationships to test the sponsor's reputation.
Watch out Brand recognition is not a substitute for diligence.
- 5
Structure downside protection
Require reasonable leverage, substantial equity capitalization, and covenants that provide early warning and negotiating power.
Pro tip Stress the structure at current and higher interest rates.
Watch out A strong business can still become a weak credit when burdened with excessive debt.
- 6
Monitor after closing
Stay involved as acquisitions, geographic expansion, and other growth initiatives change the borrower's risk profile.
Pro tip Discuss the next growth initiative before the borrower needs additional financing.
Watch out Do not treat closing as the end of underwriting.
In the wild
A lender evaluates a profitable software provider whose product is embedded in bank operations. Customers are unlikely to switch, subscriptions produce recurring cash flow, and the company leads its niche. The lender verifies sponsor quality, requires substantial equity, and sizes debt against stressed cash flow rather than projected revenue.
→ The resulting loan combines durable repayment capacity with structural downside protection.
A well-managed oil-and-gas company offers an attractive yield, but its debt capacity depends heavily on future commodity prices. Because correct operational analysis cannot neutralize that external risk, the lender declines the opportunity.
→ The portfolio avoids a risk whose outcome cannot be controlled through ordinary company underwriting.
Common mistakes
Chasing yield before quality
A high coupon can conceal a borrower that lacks enough resilience to survive a downturn or higher rates.
Confusing revenue with cash flow
Fast revenue growth does not establish the recurring cash generation required to service debt.
Ignoring leverage in a good company
Even a market leader can become a poor credit when its capital structure leaves too little margin for error.
Is it for you?
Best for
It is best for lenders evaluating established, sponsor-backed middle-market companies.
Not ideal for
It is not ideal for venture-stage companies, turnaround financing, or commodity speculation.
From the transcript
“We focus on quality, We focus on market leaders.”
“market leaders recurring revenue, recurring cash flow, information services, software, healthcare, distribution, logistics, business services.”
“we could be completely right on the credit but wrong on the commodity.”
From the episode
Ken Kencel on the Rise of Private Capital
Ken Kencel