Mike Milken, the Junk Bond King, and Three Pillars of Private Credit: Structuring, Convexity, and Capital Velocity
By Elham Saeidinezhad
Personal Note
My first job after grad school was at the Milken Institute, where I focused closely on capital markets and credit. That experience left a lasting impression—especially Milken’s approach to structuring and credit as tools for transformation.
Private credit has since become a central theme in my work: it’s a chapter in my upcoming book, the subject of a paper I’m writing, and the focus of two panels I’m organizing at the upcoming Market Microstructure Symposium (in collaboration with the Hedge Fund Association).
The more I’ve explored this world, the more I’ve found that Milken’s framework—his way of thinking about high-yield credit—is still one of the best tools for understanding today’s private capital markets. This piece is a sketch of that evolving framework, shaped with help from two exceptional RAs: the fantastic Kai Owen and the fascinating Itai Dreifuss.
Executive Summary
Private credit has transitioned from a niche financing option into a core pillar of modern capital markets. Yet despite its rapid growth, it remains loosely defined and analytically underdeveloped. Discussions often revolve around what it lacks—such as transparency, standardized ratings, or daily liquidity—rather than what internal logic drives its evolution.
This paper proposes that the most coherent framework for understanding private credit is rooted in the intellectual structure originally developed around high-yield bonds. Drawing on insights from Michael Milken’s reframing of credit markets, the paper introduces three structural pillars that explain how private credit operates: Dynamic Risk Sharing, Convexity Thinking, and Capital Velocity.
These pillars shed light on how private credit allocates risk, anticipates market movements, and creates liquidity not through trading, but through engineered structures. By integrating these elements, private credit emerges not as a marginal asset class but as a parallel credit system—one that is increasingly central to modern financial architecture.
Too often, private credit is defined by its absences—no ratings, no benchmarks, no daily liquidity—instead of by the structural logic that makes it work.
Introduction
Private credit markets have expanded rapidly over the past two decades, encompassing a range of instruments such as direct lending, asset-based finance, mezzanine loans, special-situations credit, and NAV-based lending. These markets now account for trillions in global assets under management. Yet for all this growth, private credit remains conceptually under-theorized. It is often described by what it lacks—public disclosure, ratings, exchange trading—rather than by what drives its internal logic.
Credit is not just a priceable risk—it is a designable structure.
To better understand this space, I turn to a foundational insight: that credit is not merely a priceable risk, but a designable structure. This principle, core to Milken’s approach to junk bonds, also underlies the architecture of today’s private credit markets. By focusing on structure rather than surface, we can identify three core mechanisms that define private credit’s logic:
Dynamic Risk Sharing through Structuring
Convexity Thinking over Yield Curve Thinking
Capital Velocity as a Source of Engineered Liquidity
Pillar 1: Dynamic Risk Sharing Through Structuring
Public bond markets typically rely on standardized issuance and credit ratings. Once a bond is issued, its risk profile is largely fixed, and investor focus shifts to managing exposure via trading or hedging.
Private credit turns this sequence around. Risk is not passively received; it is actively structured into the deal. In financial engineering terms, structuring refers to the process of designing a transaction’s components—such as cash flow rights, covenants, collateral arrangements, and payment hierarchies—to allocate and manage risk across participants. Features like floating-rate instruments, performance-based triggers, bespoke covenants, collateral packages, and subordinated tranches allow investors to customize how different types of risk are absorbed, transferred, or mitigated throughout the life of the deal.
This reflects a fundamental principle in modern portfolio theory: diversification and risk allocation are most effective when incorporated during the portfolio construction phase, not after the fact. Applied to private credit, this means that risk isn’t something to be managed reactively in secondary markets—it’s something to be actively structured at the outset.
Through tools such as covenants, tranching, interest rate resets, payment waterfalls, and collateral layering, lenders and borrowers co-engineer credit transactions that distribute different forms of risk—credit risk, interest rate risk, liquidity risk, and operational risk—across counterparties in a deliberate and pre-agreed manner.
For example, senior lenders might receive tighter covenants and priority claims, while subordinated tranches absorb more downside risk in exchange for higher return potential. Interest rate mechanisms might be adjusted to pass along market movements to borrowers, and collateral arrangements are crafted to secure exposure in ways that reduce the need for later renegotiation or hedging.
Where public markets price risk and manage it later, private credit designs the risk itself—right into the bones of the deal. In other words, public markets hedge risk. Private credit structures it.
This stands in contrast to public debt markets, where the risk premium is priced and fixed at issuance, and risk management typically occurs later—through trading, hedging, or secondary market adjustments. In private credit, by contrast, the structure of the debt itself—through tranching, covenants, NAV-based features, and other engineered mechanisms—acts as the de facto form of risk management.
This mirrors an important hierarchy in modern portfolio theory: risk-sharing belongs to the construction phase of the portfolio, while risk management occurs after the portfolio is formed. Private credit collapses that distinction. Because structuring dynamically shares and distributes risk upfront, the need for active, reactive risk management later is often significantly reduced. What emerges is a bespoke credit profile that reflects both the borrower’s constraints and the investor’s return and risk preferences—aligned through intentional design rather than aftermarket correction.
Pillar 2: Convexity Thinking Over Yield Curve Thinking
Traditional fixed income models rely on static risk assessment frameworks—specifically, the risk structure and the term structure of interest rates. The risk structure explains how credit risk affects interest rates across different borrowers at a single point in time, while the term structure captures how interest rates vary with the length of time to maturity. These frameworks underlie the predominance of fixed-income instruments in public debt markets, where most securities are issued with fixed coupons and fixed terms to maturity. This structure simplifies valuation, enables benchmark comparison, and supports liquid secondary trading. Together, these models assume relatively stable relationships between time, credit quality, and return, emphasizing current pricing over evolving risk dynamics.
Private credit isn’t about where the spread is—it’s about where it’s going.
Private credit practitioners think differently. They often focus not on the absolute level of spreads, but on the potential for spreads to compress—that is, the narrowing of yield differentials between risky and less risky credits as market conditions or issuer fundamentals improve. In private credit, this often occurs when a borrower transitions from a distressed or unrated state to a more stable and creditworthy position, either through operational improvement or strategic restructuring. Alternatively, investors may engineer spread compression by embedding credit enhancements—such as tighter covenants, improved collateral coverage, or subordinated capital layers—into the deal structure itself. Spread compression becomes a key value driver because it enables investors to earn returns not only from the contractual interest payments but also from mark-to-market gains as the borrower's perceived credit risk declines.
For example, consider a private lender who provides financing to a company undergoing a turnaround. Initially, the loan may carry a spread of 800 basis points over SOFR due to high perceived risk. As the company improves operations, secures additional equity backing, and begins to meet performance covenants, the market may reprice the loan to reflect only a 500 basis point spread. Even if the lender continues to hold the loan, the improvement in perceived creditworthiness increases the market value of the asset—generating unrealized gains that can be monetized through securitization, secondary sale, or as part of NAV-based borrowing. These repricings are often triggered by operational turnarounds, upgrades by internal or external credit assessments, shifts in macroeconomic sentiment, or capital market arbitrage opportunities. This is convexity thinking: a sensitivity to second-order effects, where small changes in underlying risk or behavior can produce outsized returns.
Milken’s original insight—that undervalued credit can reprice as the market re-evaluates risk—remains central. Investors are not just being paid for taking risk; they are betting on how risk is likely to change over the life of a deal. This requires underwriters to account for path-dependence, optionality, and embedded catalysts.
Path-dependence refers to how the future evolution of a credit position depends on the specific sequence of events or performance milestones along the way, rather than just its current status. Optionality reflects built-in features that allow borrowers or lenders to adjust terms under certain conditions—such as early repayment rights, step-up coupons, or performance-based pricing. Embedded catalysts are deal features or external events (like M&A, refinancing, or regulatory changes) that can trigger a revaluation of risk. Structuring in private credit is therefore not just about managing today's exposures but about anticipating and harnessing these future inflection points to create value.
Milken’s original insight remains central: in credit, the payoff often lies not in taking risk, but in anticipating how it will change. That’s why private credit underwriters don’t just price static exposure—they model path-dependence, build in optionality, and structure around embedded catalysts.
Pillar 3: Capital Velocity Engineered Liquidity Over Market Liquidity
Private credit lacks the trading-based liquidity of public markets. But that doesn’t mean it lacks liquidity altogether. Instead, liquidity is generated through capital velocity—the ability to recycle, refinance, and repackage capital across multiple transactions. In public markets, liquidity depends on the existence of continuous secondary trading, supported by standardized terms and transparent pricing. In contrast, private credit markets create liquidity by embedding exit mechanisms into deal structures themselves—such as refinancing triggers, repayment schedules, or embedded take-out provisions. The emphasis shifts from being able to sell an asset quickly on a market to designing the asset in a way that ensures capital can be turned over and re-deployed efficiently. This structural design allows institutions to maintain portfolio agility and support new deal flow, even in the absence of deep secondary markets.
Private credit doesn’t depend on trading for liquidity; it manufactures it through capital velocity.
This is achieved through a variety of mechanisms that enable credit risk to be redistributed (linking the third pillar with the first pillar and securitization), capital to be recycled through secondaries (linking the third pillar with the second pillar, NAV loan, etc), and liquidity to be engineered:
Loan securitization (e.g., CLOs, ABS): Bundling and selling loan exposures as tradable securities, allowing originators to remove risk from their balance sheet and reinvest proceeds.
Re-securitization and tranching of structured products: Creating new layered securities out of existing structured products to appeal to different risk-return profiles and optimize capital efficiency.
Syndication and LP-led secondary sales of private loan exposures: Selling or sharing exposure to existing loans among multiple investors to free up balance sheet capacity and create liquidity.
GP-led secondaries and NAV-based facilities in private equity-backed credit: Providing exit or recapitalization options to existing investors through asset-level refinancing or lending against fund NAV, extending the capital lifecycle and injecting liquidity into otherwise illiquid positions.
In this model, liquidity is not an external market feature—it is endogenously created. Instruments are structured with exit pathways (e.g., take-outs, refinancings, repayments) embedded into the deal itself. This reflects a shift from market-based liquidity to design-based liquidity, where financial innovation substitutes for market depth.
Conclusion: A Structural Theory for a Parallel Credit System
Together, these three pillars provide a cohesive framework for understanding private credit as a structurally distinct domain of finance.
Dynamic structuring replaces standardized issuance.
Convexity thinking replaces yield curve analysis.
Capital velocity replaces market-based liquidity.
Private credit is not merely "illiquid public debt"—it is a parallel credit system optimized for customization, adaptability, and innovation. Drawing on Milken's original insight—that credit is a tool to be shaped rather than a static product—modern private credit continues to push the boundaries of how financial capital can be structured and deployed.
Understanding this system is essential for investors seeking alpha, for regulators managing systemic risk, and for scholars aiming to capture the financial architecture of the 21st century.
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