Warning! Private credit has a valuation problem

Investments that are not traded daily on an exchange like nontraded business development companies should come with giant warning labels in red and gold. 

Such signs should be on the walls of financial advisors' offices, similar to “do not operate” placards around heavy machinery in factories.

Their purpose would be to alert advisors’ clients - who buying the products - of enormous risks they may add to their portfolios.

Chief among these risks would be the revelation that no one really, really knows what type of per share or net asset value these products actually create.

“Warning!” the stickers should read. “This firm, the asset manager and I, your trusted financial advisor, don’t really know what the loans we’re buying with your money are really worth. That’s the truth.”

“Warning! In fact, our process relies a lot on prognostication and guesswork, albeit sophisticated guesswork based on the work of a lot of smart people.”

“Warning! But when the market for private loans goes a little wonky, all bets are off. Sorry.”

“Warning!”

The executives and lawyers who control the financial advice industry, of course, would never allow for such simple yet bold signs of caution.

They make too much money from the sale of high-fee products like nontraded BDCs and nontraded real estate investment companies, which are typically sold to clients who want yields above and beyond what they can get in government bonds and cash.

But the ongoing concerns linked to private loans, often called private credit, and nontraded BDCs, investment funds that act like mini-banks and finance the loans of mid-sized private companies, are just the latest troubling sign for an industry that has sold tens of billions of dollars of such products to retail investors in the past half decade.

Investors have woken up to worries about BDCs' exposure to loans to private software companies, which are under pressure because of the potential for artificial intelligence to wipe them off the map.

The latest cause for concern has been a series of recent moves by prominent BDC manager Blue Owl Capital Inc., which trades with the ticker OWL.  

In November, Blue Owl Capital Corp. II declared its intent to merge this unlisted BDC into listed BDC Blue Owl Capital Corp., with the ticker OBDC.

(It’s a lot of owls, which makes it only more confusing for the investor.)

“An uproar ensued,” Morningstar said in a research note last week. “With the market price of OBDC’s very similar portfolio trading at a roughly 20% discount to its NAV, the merger made it highly likely that OBDC II investors would immediately suffer a 20% markdown on their investment.”

There’s where the Warning! signs for alternative investments would be relevant. No one know how these loans will ultimately be valued.

No one.  

“Days later, Blue Owl canceled the planned merger amid a drop in its own publicly traded stock,” according to Morningstar.

Fast forward to this month, when Blue Owl Capital announced that it had sold $1.4 billion worth of private direct lending assets from three of its funds at 99.7% of par value.

“Out of that total amount, $600 million came from [Blue Owl Capital Corp. II], representing roughly one-third of the fund’s net asset value,” according to Morningstar. “The bulk of that will be returned to shareholders, representing a substantial portion of the fund’s assets and equivalent to more than one full year’s worth of redemption offers.”

The market is unhappy with private credit. The share price for OWL at 3:00 p.m. ET Wednesday was $11.44, a decline year-to-date of 23.5%.

Other private loan and BDC managers have also seen their share prices decline.

“Over the last three or four years, sponsors and managers of BDCs were treating financial advisors and clients like fat kids at the bakery who were eating everything in sight,” said Kevin Gannon, chairman and CEO of Robert A. Stanger & Co. Inc. “Now they’re puking it back up.”

“The alternative space is always intoxicated by high yields,” he added.

Sounds like the private credit and BDC party is over.

Boaz Weinstein, the founder of Saba Capital Management, said the questions raised by Blue Owl Capital’s nontraded BDCs may be an early sign of wider instability in the $1.8 trillion private loan market.

“All you need is the snowball to start going down the hill and it started. Blue Owl is right in the middle of that,” Weinstein said at a conference in Miami Beach, Florida, Bloomberg reported. “I think we are in the super-early innings of the wheels coming off the car.”

To be fair, Saba Capital is looking at the private loan market opportunistically; it has offered to buy stakes in Blue Owl funds at substantial discounts to current NAVs.

Nontraded BDCs will feel pain in 2026 because sales will be down because of this series of negative news, meaning funds will have less capital to lend. Revenue will be harder to generate.

Meanwhile, clients will be running for the exits each quarter, redeeming up to 5% of each fund’s shares, another drawdown on capital.

Warning!