Hints of a private credit crisis rattle investors

“Generals are always prepared to fight the last war,” as the old adage goes. It is easy to base our expectations on what happened in our last big bull market or bear market. This is why some modest rumblings in private credit are getting so much attention. Anybody who sat through the prelude to the global financial crisis as subprime mortgages went awry may feel they’ve seen this before.

The latest wobble here involves Blue Owl, an alternative investments manager that is heavily exposed to the private credit market, and two of its funds: a listed fund called Blue Owl Capital Corporation, known by the ticker OBDC, and an unlisted fund called Blue Owl Capital Corporation II, known as OBDC II.

Late last year, redemptions in OBDC II rose to a point where it would have had to halt redemptions. So Blue Owl proposed that OBDC II merge into OBDC. Since OBDC is listed, investors would have been able to sell shares at any time.

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However, the terms of the merger would effectively have marked down the value of investments in OBDC II by 20%, since OBDC was trading on a discount to net asset value. Unhappy investors squashed it.

Now Blue Owl has said that regular redemptions in OBDC II will be halted permanently anyway.

Investors will get back 30% of their capital soon, with the rest returned over the coming years. The 30% will be funded by selling part of OBDC II’s portfolio to new Blue Owl-run vehicles backed by US pension funds as well as an insurer owned by Blue Owl. OBDC and another Blue Owl fund are also selling assets in the same deal.

The bullish argument is that although OBDC trades at a discount to net asset value and skittish investors have been pulling their money from OBDC II, institutional investors are willing to buy the assets at solid prices (99.7% of carrying value).

Cynics will counter that the new investors will be buying the best loans and that some of the rest of the portfolio would not trade so well. We can’t know which take is fair and that’s the problem.

Private credit troubles could weigh on the wider market

Investors are clearly getting more nervous about private credit. They worry that some funds have lent a lot to software and tech businesses that could, variously, face an existential threat from AI or from an AI bubble bursting (choose your poison).

The lack of transparency in the sector makes it hard to see how well loans are performing and how strong lender protections are. And if they get rattled, they have every reason to rush for the exit while they still can.

This does not mean that private credit is set to be the subprime crisis of this cycle. We don’t want to plan for the last war. So we shouldn’t look at this as the same kind of systemic threat that will spark a global meltdown. Yet given the substantial role that private credit now plays in fundraising and financing, a seize-up here could put the wider market under more pressure.

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