Important points
Private credit investors could face a potential “off-ramp” as pressure mounts to cash out money from the $3 trillion industry. Asset managers in the sector, where so-called semi-liquid funds have made inroads into the private wealth market, have scrambled in recent weeks to limit investor withdrawals over concerns that bad loans could cause soaring default rates and a “rush to cash” among investors. Sunaina Sinha Haldea, global head of private capital advisory at Raymond James, said there was a “robust, growing and highly innovative” private secondaries market for investors to sell short. Giving private fund shares to other buyers could act as a pressure valve for investors looking to exit without forcing management to sell the underlying loans. Haldea pointed to Boaz Weinstein’s activist hedge fund firm, Saba Capital. The company, along with Cox Capital Partners, has launched tender offers to acquire shares in a number of private debt vehicles, including those managed by Blue Owl Capital. “We’ve seen it come out publicly that Boaz Weinstein of Saba Capital is offering bidding solutions that give ramp-off liquidity to BDC investors in these private credit funds,” Haldea told CNBC’s “Squawk Box Europe.” “Increasingly, retail investors will use the secondary market to secure an exit to semi-liquids that they potentially didn’t understand…This is illiquid paper. You can’t force them to sell paper just because they want to redeem it.” Rising Redemptions The recent surge in redemption requests across private credit is raising new questions about whether the industry’s high-yield but less liquid vehicles are appropriate for retail investors. Haldea said the gates for semi-liquid products are “rising left, right and center” and “will continue to do so.” He added that certain products and structures designed for institutional investors are being “repackaged and repurposed” in private asset channels as semi-liquid products, which “poses a risk”. OWL 1M Mountain Blue Owl Capital. Cliffwater moved to curb investor redemptions last week after redemption requests from its flagship fund, the Cliffwater Corporate Lending Fund, soared to 14%. The company, which has about $70 billion in private debt assets, agreed to buy about 7% of the fund. Separately, Morgan Stanley restricted withdrawals from its $7.6 billion Nothaven Private Income Fund after redemption requests rose 11% in the first quarter. Cliffwater is the company Saba Capital is “watching most closely,” Weinstein told CNBC in a recent interview. ‘Mark-to-market thinking’ Saba Capital’s bid includes a plan to buy a 6.9% stake in non-traded Blue Owl Capital Corporation II, also known as OBDC II, for $3.80 in cash per share. Blue Owl Capital Corp. II, a U.S. retail business development firm, last month overhauled its quarterly liquidity requirements and sold some of its direct lending assets to several North American pension funds in secondary-style transactions that provide liquidity to investors. Haldea warned that if investor sentiment deteriorates sharply, the secondary market could struggle to absorb a wave of large redemptions. “Is that market big enough to sustain it if the floodgates fully open and there’s a full outbreak? No, it’s not. But is it enough today? We’re seeing that it’s enough, with these organizations coming together quickly to organize liquidity,” she added. Oppenheimer & Company senior analyst Chris Kotowski said the withdrawal limit is “a feature, not a bug” because the fund invests in illiquid loans that are meant to be held to maturity. Kotowski said on CNBC’s “Squawk on the Streets” that many commentators still have a “mark-to-market mentality,” adding that the private debt structure allows the fund to earn an illiquidity premium and avoid forced sales during times of market stress. “Liquidity restrictions are intended to generate total returns over the long term,” he said. While recent market turmoil has spooked investors, Kotofsky said private credit management companies have historically emerged stronger from economic downturns because of their long-term capital structures. “The market is very new to how resilient these companies are,” he said. “Of all the major credit cycles, the credit cycle is by far the strongest.” Rising defaults But that structure is now being tested. Industry experts worry that the underlying loan quality and the sector’s exposure to software companies at risk of disruption from AI could push default rates well above the historical average of around 2%. Partners Group Chairman Stefan Meister said in a recent interview with the Financial Times that the default rate could double in the next few years, and Morgan Stanley analysts suggested the default rate could reach 8%, Bloomberg reported on Tuesday. “Was there a loan written with terms that were a little too lenient and conditions that could be broken? That’s right,” Haldea said, adding that default rates could rise further as loans weaken. “The penny isn’t done falling yet.”
