Private credit has a structural problem

Unlock the Editor’s Digest for free

Roula Khalaf, Editor of the FT, selects her favourite stories in this weekly newsletter.

In New York, it’s snowing hard again and Unhedged is over it. We have nothing nice to say about the month of February and have our doubts about January and March, as well. Send us warm and sunny thoughts, financial or otherwise: unhedged@ft.com.

Private credit: the loans are not the problem

The private credit industry is having a little trouble. 

The locus of the trouble, at least in the past week or two, has been a fund run by the asset manager Blue Owl. The fund, Blue Owl Capital Corp II, was designed with individual investors in mind, and offered quarterly redemptions of up to 5 per cent of the fund’s value. This is in contrast to private credit funds for institutional investors, where liquidity might be available only after several years. 

Last fall, First Brands’ bankruptcy and other slip-ups triggered talk of “credit cockroaches,” at the same time as interest rates were beginning to fall. Neither of these made private credit any more appealing as an investment. BOCCII began to face heavy redemption requests and stopped taking new investments. Blue Owl’s solution to this was to merge it with a larger, public fund, OBDC. 

As my colleague Antoine Gara was first to point out, this plan created a problem. OBDC, as a publicly traded Business Development Company, trades at whatever price the stock market decides it should. At the time, that price was at a 20 per cent discount to the fund’s net asset value (as determined by Blue Owl). BOCCII, as a private fund, offered quarterly redemption at net asset value. So BOCCII holders stood to take a 20 per cent loss when their assets were merged into OBDC. So the right move for them would have been to redeem at NAV — but Blue Owl forbade it.

A few days after Antoine’s story, Blue Owl announced that the merger was off, and that the redemption window would reopen early in 2026. But last Wednesday, Blue Owl said there would be no redemptions; instead the company would return investors’ capital episodically in quarters and years to come. It has already sold a big chunk of loans near par value and plan to redistribute the proceeds.

The turnabout has made investors nervous about the whole industry. Asset managers with exposure to private credit, already sliding this year, ended last week falling further still:

The worries stalking private credit are not limited to falling rates and careless underwriting. There is also the fact that managers have moved aggressively into software lending just in time for AI to throw the future of that industry into question. But the crucial point is that none of these worries is the industry’s fundamental problem right now. The core issue, instead, is that selling private credit funds to retail investors is a mistake.

One key virtue of private credit is that lenders can reap an illiquidity premium — a higher interest rate — when they lend to borrowers who want to avoid the daily pressures of the high-yield bond market. Another, related virtue is the lack of mark-to-market pricing of loans, which creates the appearance of investment returns uncorrelated with the swings of public markets. But when you sell private credit investments to retail investors, you have to offer them a degree of liquidity. In doing so, you create an irreducible tension, as the travails of BOCCII are demonstrating now.

Blue Owl (and many others) have tried to square the circle by offering limited liquidity — quarterly redemptions in limited amounts. But demands for liquidity ultimately broach no limits: if anybody is told they can’t get out, everybody wants out, without waiting around to assess credit quality or contemplate the true impact of AI on the software business. And this rush to the exit will happen any time when investors realise that there is a meaningful gap between the “uncorrelated”, “stable” mark of a private asset and what that asset could be sold for at the moment. But the existence of such a gap is one of private credit’s key selling points! The internal contradiction is unsustainable and intrinsic to the product.

What is really interesting is that we all saw this coming. Predictions that retail-oriented private credit products would lead to a mess were everywhere, right from the get-go. That the products got built and sold anyway tells you something about the power of Wall Street’s marketing and distribution machine.

Tariffs: the end of the beginning

Markets didn’t respond much to Friday’s news that Trump’s “emergency” tariffs had been found illegal. Shares of import-dependent retailers spiked a bit when the news hit, but the excitement was mostly fleeting. Treasury yields were unmoved. The dollar nudged up a little. The indifference makes sense. The Supreme Court’s verdict was widely expected and priced in. And, more importantly, tariff uncertainty has not fallen. In fact, it has probably got worse. 

Trump quickly announced a 10 per cent, then 15 per cent, global tariff rate under section 122 of the Trade Act of 1974, which allows him to set import restrictions temporarily. And the various post-“liberation day” trade deals and investment pledges are now up in the air. These deals “were contingent on the threat of the so-called liberation day tariffs. If those are null and void, then one has to expect that our partner countries will want to vacate the subsequent ‘deals’ that were frankly extortionary,” according to Marcus Noland at the Peterson Institute for International Economics. 

The biggest fiscal headache is whether tariff refunds are owed, and to whom. Libby Cantrill at Pimco estimates that the US has pocketed around $175bn in tariffs under IEEPA — around half of its overall tariff revenue — and, theoretically, has to pay it back. Repayments will increase the fiscal deficit. The Committee for a Responsible Federal Budget estimates that the Scotus decision and refunding of tariffs would increase debt by $2.4tn through the 2036 fiscal year (this forecast was issued before Trump announced his 10 per cent global tariffs). 

From the perspective of retail and auto manufacturers, who were among the hardest hit by tariffs, the ruling likely won’t change much. Per Hong at Kearney expects pricing architecture and inventory timing to persist as ongoing issues. “Many have already absorbed portions of tariff costs to protect demand, while simultaneously diversifying sourcing beyond China. While we’ll see how this plays out, this ruling does not unwind those structural shifts,” notes Hong. 

Economic uncertainty has always been the biggest cost of Trump’s trade policies. The Supreme Court ruling does not fix it. Until there’s more clarity on the new policy baseline and on repayments, stocks, Treasuries and the dollar will continue to face the same headwind they have sailed into since last April.

One good read

Progress?

FT Unhedged podcast

Can’t get enough of Unhedged? Listen to our new podcast, for a 15-minute dive into the latest markets news and financial headlines, twice a week. Catch up on past editions of the newsletter here.