Introduction

The capital stack is the organising principle of any financing transaction. It dictates priority of claims, defines risk allocation, and ultimately determines the distribution of returns. For private credit investors, clarity on stack positioning is non-negotiable: the same yield can carry entirely different implications depending on whether it is earned at the senior, mezzanine, or equity layer.

In structured private credit, where transactions are often securitised through Credit Linked Notes (CLNs), understanding the capital stack is central to evaluating the real exposure behind the coupon.

Components of the Capital Stack

Senior Debt

Secured, first-ranking, and contractual. Senior debt benefits from direct claims on collateral and first access to cash flows. It delivers stability and capital preservation but offers limited return potential. For allocators, it functions as the core income sleeve of private credit portfolios.

Mezzanine Debt

Subordinated to senior claims, typically unsecured but compensated by higher coupons and occasionally equity conversion rights. Mezzanine is used to bridge funding gaps, enhance leverage, or fund growth. Returns are attractive, but risk of impairment rises sharply in stressed conditions.

Preferred Equity

Hybrid capital that ranks above common equity but below all debt. Investors receive priority distributions, often structured as fixed dividends. Preferred equity lacks security but provides contractual income streams with partial upside participation.

Common Equity

Residual capital, absorbing first losses but capturing all remaining upside. Common equity provides the buffer beneath debt investors and signals alignment of interest by sponsors. For credit investors, equity capital is the margin of safety underpinning their tranche.

Why Stack Positioning Matters in Private Credit

The capital stack is not simply hierarchy; it is the lens through which every private credit allocation must be assessed.

  • Risk pricing: Coupons only make sense in the context of subordination. A 10% yield at the senior layer is extraordinary; at the mezzanine layer, it may not be adequate.
  • Governance: Rights, covenants, and control provisions differ by tranche. Senior debt holders dictate terms; mezzanine and preferred equity holders accept limited influence in exchange for yield.
  • Recovery dynamics: In default scenarios, losses cascade up the stack. Equity is wiped first, followed by preferred, then mezzanine. Senior lenders are impaired last.
  • Portfolio construction: Institutions blend stack exposures to achieve balance between contractual income, diversification, and opportunistic return.

Structured Credit and the Stack

In structured solutions such as CLNs, the capital stack is explicitly defined within the issuance. Investors can select tranches aligned to their mandate: senior for predictable income, mezzanine for enhanced yield, or hybrid exposures for balanced risk.

The advantage of securitisation is clarity. Tranche documentation, collateral pools, and waterfall structures ensure investors know exactly where they sit in the stack — a discipline often missing in bilateral private credit transactions.

Institutional Perspective

For allocators, the critical questions are not about definitions but about alignment:

  • What tranche am I in, and what sits beneath me?
  • How much equity capital is providing first-loss protection?
  • Do the covenants, collateral, and governance mechanisms adequately reflect my position?
  • How does this stack exposure aggregate with the rest of my portfolio?

Answering these questions ensures that private credit allocations are not simply yield-chasing exercises but disciplined investments aligned with long-term objectives.

Conclusion

The capital stack is the framework through which risk, control, and return are distributed. For private credit investors, ignoring it is equivalent to investing blind. Whether through senior secured loans, mezzanine financings, or CLN tranches, stack positioning dictates outcomes in both benign and stressed environments.

For family offices and institutional investors, disciplined assessment of stack exposures is fundamental. Private credit rewards precision, and the capital stack is the map that ensures capital is deployed with clarity, protection, and purpose.