Skin in the game, loan by loan

Almost every private credit structure claims alignment. The claims are not equivalent, and the difference shows up only under stress.

The common form is a commitment at the relationship level. The lender that introduced the loans holds a stake in the vehicle, or gives a guarantee covering them, or retains a strip across the book. In each case the exposure is to the portfolio in aggregate.

What aggregation does

Aggregated exposure lets a weak loan be averaged against strong ones. A lender carrying a slice of a book can write a loan it is unsure about and rely on the rest of the book to carry it. Nothing improper has happened. The structure simply does not make that loan expensive enough to refuse.

It also makes the protection contingent. A portfolio guarantee is a claim against a balance sheet, and its value depends on the state of that balance sheet at the moment it is called, which tends to be the worst possible moment.

What per-loan exposure does

If the commitment sits inside each loan rather than across the relationship, the arithmetic changes at the point of origination. The firm introducing the loan is putting its own money into that specific credit, and it cannot be recovered out of the performance of a different one. A loan it is unsure about is a loan it pays for.

It also changes what happens when something goes wrong. The money is already inside the loan. Nobody has to be asked to honour anything, and no balance sheet has to be in a particular condition on a particular day.

That is the whole distinction, and it is not subtle once a loan stops performing. Alignment that has to be called is not the same as alignment that is already there.