Keep reading
Blog/Private Credit
A credit memo is the internal document that asks a lender’s credit committee to approve a loan. A good one states the recommendation and terms on page one, then proves three things: how the borrower repays, what protects the lender if trading weakens, and what the lender recovers if the plan fails.
If you work in direct lending, leveraged finance or a bank credit team, the memo is the main thing you are judged on. The committee will read the first two pages closely and test every number behind them.
This guide covers the standard structure, a step-by-step method with a worked example, and the mistakes committees catch most often.
The memo serves two readers: the committee deciding today, and the portfolio managers, auditors and regulators who later check why the loan was approved.
Bank supervisors have long framed credit around repayment from cash flow. The OCC’s Comptroller’s Handbook on commercial loans says “cash flow is the most common source of repayment.” For highly leveraged transactions it goes further: if operating cash flow is insufficient, other sources of repayment are generally too tenuous to support the loan.
The classic checklist is the five Cs of credit, as Wall Street Prep lists them: character, capacity, capital, collateral and conditions. In a lending memo they mean:
In a sponsor-backed deal, character usually means the private equity owner. Our guide to sponsor-backed vs non-sponsor lending explains how that changes structure and documents.
Formats differ by firm, but most credit memos follow this order:
Open with the decision you want. Then give the terms in a short table or list: borrower, facility type, amount, tenor, margin, fees, call protection, opening leverage, loan-to-value and covenants.
Make each term clear and measurable, the standard the Federal Reserve’s SR 13-3 letter set for leveraged lending underwriting. Follow with three to five bullet points on why the loan should be approved and the two or three biggest risks. Draft this summary last so it reflects the analysis.
The terms here should match the term sheet exactly. Our article on the term sheet process in private credit covers how those terms are negotiated.
Keep this section short and specific. Explain what the company sells, who pays for it, how revenue recurs and what drives margins.
Name the concentrations: top customers, suppliers, products and regions. Then set out the transaction with a sources and uses table, so the committee sees how much equity the sponsor is contributing. Much of this comes from the sale document, so read our explainer on the confidential information memorandum with a sceptical eye.
Every ratio in the memo depends on EBITDA, so rebuild it yourself. Start from reported EBITDA, then accept, haircut or reject each adjustment in the quality of earnings report and the sponsor’s model.
Regulators have flagged this weakness for years. Paul Hastings’ summary of the 2014 Shared National Credit review notes examiners found weaknesses in credit analyses, including difficult-to-support adjustments in EBITDA calculations and overreliance on borrower or sponsor base case projections. Our guide to EBITDA add-backs in private credit sets out which adjustments usually survive.
Then move from EBITDA to cash. Deduct capex, cash taxes and working capital needs to get the cash flow that actually services debt.
Show leverage, interest coverage, fixed charge coverage and liquidity for each year of the loan under at least two cases. Use market data to sense-check your numbers. KBRA’s Q2 2026 middle market compendium put median gross leverage at 6.1x and median interest coverage at 1.6x across more than $1.2 trillion of direct lending debt.
Here is an illustrative example with made-up numbers.
Assumptions: EBITDA $10.0m, purchase price 10.0x, unitranche loan 5.0x, all-in rate 9.5% (example base rate 4.0% plus 5.5% margin), capex $1.5m, cash tax $1.0m, 1% annual amortisation.
Purchase price = 10.0x x $10.0m = $100.0m.
Debt = 5.0x x $10.0m = $50.0m.
Equity = $100.0m – $50.0m = $50.0m (loan-to-value 50%).
Interest = 9.5% x $50.0m = $4.75m.
Amortisation = 1% x $50.0m = $0.5m.
Interest coverage = $10.0m / $4.75m = 2.1x.
Fixed charge coverage = ($10.0m – $1.5m – $1.0m) / ($4.75m + $0.5m) = $7.5m / $5.25m = 1.43x.
Now cut EBITDA by 25% and cash tax to $0.5m.
Downside EBITDA = $10.0m x 75% = $7.5m.
Leverage = $50.0m / $7.5m = 6.7x.
Interest coverage = $7.5m / $4.75m = 1.6x.
Fixed charge coverage = ($7.5m – $1.5m – $0.5m) / $5.25m = $5.5m / $5.25m = 1.05x.
The two cases side by side:
| Metric | Base case | Downside case |
|---|---|---|
| EBITDA | $10.0m | $7.5m |
| Total leverage | 5.0x | 6.7x |
| Interest coverage | 2.1x | 1.6x |
| Fixed charge coverage | 1.43x | 1.05x |
| Cash after debt service | $2.25m | $0.25m |
Free cash flow after debt service falls from $2.25m to $0.25m, so the business still pays its lenders. Note that the stressed interest coverage of 1.6x equals KBRA’s current median. A typical middle market borrower today already looks like this example’s downside case, so your downside needs to go further than a modest haircut.
Now test the covenant. Assume no cash on the balance sheet, so total and net leverage are the same. A 6.5x leverage covenant set with 30% headroom over the 5.0x opening level gives only a 23% EBITDA cushion (1 – 5.0 / 6.5).
A 25% fall in EBITDA therefore breaches it, at 6.7x on opening debt or 6.6x after one year of amortisation ($49.5m / $7.5m). That gives you a seat at the table while the company still has cash, which is exactly what you want the memo to show. Our post on private credit covenants explains how headroom is set.
Assume the company defaults at the downside EBITDA of $7.5m. Estimate enterprise value at a distressed multiple, deduct restructuring costs, and compare what is left with the debt ranking at or ahead of yours, including any super senior revolver drawn at default.
Value at 7.0x = 7.0 x $7.5m = $52.5m, which covers the $50.0m loan with only $2.5m (5%) to spare before costs.
Value at 6.0x = 6.0 x $7.5m = $45.0m, which covers 90% of the loan.
State the security package, the ranking and any debt that could be added ahead of you. Our article on direct lending defaults and recoveries gives context for what lenders recover in practice.
Give each risk one line, then the mitigant and the monitoring trigger. Keep it to the five to eight risks that could cause a loss.
Close with the diligence still outstanding, who owns each item and whether approval depends on it. A conditional approval with clear conditions is better than a memo that hides gaps.
Committees tend to send memos back for the same few reasons:
Older bank benchmarks still work as sense checks. Paul Hastings notes that under the 2013 interagency leveraged lending guidance, leverage above 6.0x total debt to EBITDA raised concern for most industries, although 6.0x was never a bright line.
The guidance also looked at whether a borrower could fully amortise senior secured debt or repay at least 50% of total debt over five to seven years, though failing that test did not automatically make a loan non-pass. The OCC and FDIC withdrew it on 5 December 2025, and OCC examiners still review underwriting and risk ratings.
Long enough to support the decision and no longer. Put the model, legal summaries and third-party reports in an appendix and keep the main body tight. Write the first two pages so a committee member who reads nothing else can vote.
A private equity memo argues for upside: returns, value creation and exit. A credit memo argues for repayment and protection: cash flow coverage, covenants, security and recovery. Lenders earn a fixed return, so the credit memo spends most of its pages on what happens when the business underperforms.
Bank leveraged lending guidance was written for banks, and the OCC and FDIC withdrew from it on 5 December 2025. The Federal Reserve, which co-issued it, had not said by then whether it would follow. In practice, private credit fund memos cover the same ground: repayment capacity, leverage, coverage, security and recovery.
They test whether you can rebuild EBITDA, run a realistic downside and reach a clear recommendation. Expect to show leverage, coverage and liquidity over time and to explain the first covenant or cash shortfall. A firm recommendation with conditions scores better than a balanced summary with no view.
A credit memo puts the recommendation and terms first, then proves repayment, protection and recovery. Build your own EBITDA, run a downside you can defend and show exactly which line breaks first. If the committee can see how they get their money back in a bad year, the memo has done its job.
P.S. To practise building downside and recovery cases under time pressure, try the Excel Test – Distressed Debt. Our Premium Resources include additional tools you might find useful, and the Private Equity Bros newsletter brings you weekly finance updates and the latest financial reports.
Join 80,000+ readers
One email a week: markets and finance news, the latest M&A deals and reports, investor biographies and deep dives.
Free forever. Unsubscribe anytime.
