Wall Street doesn’t know whether it should love or be afraid of private credit. By the time it finds out, it might be too late.
Since its popularization after the pandemic, institutional investors‘ new favorite asset class has had quite the splash. Dozens of investment firms have made a modest fortune cutting out banks and offering an alternative directly to both borrowers and lenders. Only, the riskier profile of private credit has proven to be a quarrelsome thing.
As “shadow banks” are not restrained by the same regulations as actual banks, many have turned up risk and shrugged off rigorous underwriting in search of deals — many of which are being sold to other investors for a healthy fee. The result has been some pretty fantastic failures. That’s especially the case in the auto industry, where a number of high-profile failures shook up the financial sector in November. The failure of First Brands Group, for example, cost non-bank lenders over $1 billion.
Those risks were cast aside in January as CNBC reported that many non-bank lenders raised multi-billion-dollar follow-on rounds. Perhaps, in their mind, the risk was one of the features of a private credit vehicle. It’s easy to say that when you think you can get your money back. As some investors in Blue Owl Capital Corp II (OBDC II) are finding right now, that’s not always a given.
Blue Owl suspends withdrawals
On Wednesday, the $1.7 billion investment vehicle permanently restricted withdrawals from OBDC II. The decision comes after the ailing fund failed to merge with a larger, publicly traded fund operated by the company last year. But with redemptions rising, exacerbated in part by fears that AI will consume the sort of imperiled businesses that shadow banks lent to, Blue Owl will now pursue a liquidation of the fund.
It took a step towards winding down OBDC II by selling $600 million in assets from OBDC II, about 30% of the fund’s worth. Those investments were sold, per the Financial Times, for roughly what they were worth. And while that’s sure to settle some fears that the private credit risk rooster is coming to roost, there’s little consolation for anybody, bar maybe the borrowers who got cash for their business (and the companies charging the fees for access to the credit, of course).
Risks may vary
For lenders, a liquidation isn’t going to make up for the pittance of performance. Reuters’ Jonathan Guilford likened the situation to the fall-off in nontraded REITs after the pandemic. They have not recovered to their former highs. But one fund is still one fund, so to generalize the problem with Blue Owl (which is having problems across more than this one fund, but continues to examine deals with Meta and Oracle, for example) might be a little preemptive.
Ultimately, the acute problem is whether shadow banking offers what it says it does. If lenders don’t come out of the woodwork for private credit, maybe due to poor performance after fees or worries about the sector, that would be a problem for these firms. The result might be that investors might question whether the gravy train has as much gravy to offer.
How Did the Market React?
Today, that question is stoking carnage among the private credit crop: Blue Owl fell over 9% intraday, joined by declines from other alternative investment managers like Blackstone, Apollo Global Management, KKR, and Carlyle.
But is it an existential problem? While economist Mohamed Aly El-Erian is making headlines warning about a “canary-in-the-coalmine” situation in private credit similar to Aug. 2007, it feels too early. But if the problems with this $1.7 billion investment vehicle are representative of the whole private credit industry? Well, then we have a problem.
