Private credit market raises plenty of questions for popular BDCs

With sales of nontraded business development companies booming, some financial advisors and their clients have more exposure than ever to billions of dollars in private loans. That’s causing some concern in the financial advice industry, as falling interest rates and a cloudy outlook for the broad economy spark questions about the performance of some loans.

According to alternative investments fund tracker Robert A. Stanger & Co. Inc., nontraded business development companies (BDCs) are having a terrific year, sales-wise. Through July, sales of nontraded BDCs totaled $26.7 billion compared to a total of $35.4 billion in 2024.

The success of the BDC industry is coming at its own expense, one veteran industry executive said.

“The challenge is that some of these private credit funds are so big they have to invest in the upper end of the market and they tend to invest in same deals,” said the executive, who spoke privately about the matter to InvestmentNews. “If the loans from one of these companies hits a snag, they’re all in trouble.”

BDCs lend money to private companies - typically small- and mid-sized companies that might have trouble getting loans from banks. For the year through end of trading Friday, the S&P BDC Index was down 15.8%. The index has declined 3.2% in the past month.

First Brands fallout
 

The angst for nontraded and illiquid BDCs, which have been gobbled up the past few years by investors hunting for yield, has been triggered the past few weeks by the bankruptcies of US auto parts supplier First Brands and car dealership Tricolor. Some BDCs, along with credit-focused Interval funds, own those companies loans, according to company filings and independent reports.

Tricolor's collapse led to $170 million in charge-offs for JPMorgan Chase during the third quarter, but the bankruptcy of the subprime auto lender could be indicative of more widespread problems, JP Morgan Chief Executive Jamie Dimon told investors last week, according to the Wall Street Journal and other outlets.

"Everyone should be forewarned on this one," he said. "When you see one cockroach, there are probably more.”

"We've had a benign credit environment for so long that I think you may see credit in other places deteriorate a little bit more than people think when, in fact, there's a downturn," Dimon said.

InvestmentNews reported last week that one popular private debt fund, FS Specialty Lending Fund, disclosed it no longer had exposure to First Brands, after reporting over the summer the fund held loans of the company valued close to $26.6 million.

At the time, the fund’s exposure to First Brand’s debt was about 1.4% of its $1.9 billion in total assets. FS Specialty Lending Fund is seeking to list on the NYSE and start trading by the end of the year.

First Brands debt is or currently was held by plenty of other funds, according to Morningstar. They include the BDCs Prospect Floating Rate & Alternative Income and Great Elm Capital Corp. Interval funds with exposure to First Brands include Elington Income Opportunities; Franklin BSP Private Credit; and Calamos Aksia Alternative Credit and Income.

“Financial advisors should be looking for BDC funds with more middle market company exposure because so many of these funds are all investing in large company loans,” the executive told InvestmentNews. “Some of these BDCs have gotten so big they can’t invest in smaller company credit. They have too much client money to put to work.”