Access the Editor’s Summary for free
Roula Khalaf, Editor of the FT, picks out her top features in this weekly dispatch.
Investors are offloading publicly listed direct lending vehicles as they incur financial setbacks from non-performing debts and apprehensions mount that AI will cause widespread disruption to the software companies they have funded.
These instruments, referred to as business development companies, are exchanging hands for 82 percent of their underlying worth, their most substantial markdown since late 2022 and indicating that market participants anticipate these vehicles will encounter additional difficulties, as per computations by the FT derived from the S&P BDC index.
The decline in worth of these BDCs, which were transacted above par last September, has created apprehension within the wider $2 trillion direct lending sector, exacerbating strain on non-public direct lending vehicles that are experiencing a rise in withdrawals.
Such instruments, designated as semi-liquid funds, have been a primary catalyst for expansion for major private equity corporations, including Blackstone, Ares Management and Blue Owl, generating substantial administrative charges and assisting in the fourfold increase of holdings in BDCs dating from late 2020.
The decline in BDC values commenced last September as the Federal Reserve began reducing borrowing charges, impacting the yields provided by debt instruments, which generally align with wider financing expenses. The notable failure of two auto companies — First Brands and Tricolor — that month ignited anxieties regarding business debt solvency and lending criteria.
The divestment of BDCs has intensified anew subsequent to a series of asset devaluations at numerous substantial portfolios during the recent fortnight, comprising instruments overseen by KKR, BlackRock, New Mountain, Apollo Global and Blackstone as they reduced the recorded worth of their held debt. Funds overseen by BlackRock, KKR, Morgan Stanley and Apollo also reduced payouts on their vehicles.
Many wealthy individual investors were attracted to this sector by the generous distributions provided, with yearly aggregate yields surpassing 8 percent during the last ten years, as reported by S&P Global.
The latest reductions as well as disposal of holdings at some funds “resurfaced anxieties about the credit cycle” throughout the direct lending market, said Paul Johnson, a market researcher at KBW.
“Numerous challenges have accumulated for this sector and it will likely persist . . . until they have resolved these distribution reductions,” he said. Johnson added he believed the substantial price reductions on traded business development companies and the current examination of the sector could hinder fresh capital commitments towards non-public BDCs.
Recent financial setbacks have been distributed among a variety of business credits, such as a facility extended to Medallia, a software company acquired by a tech-centric private investment company Thoma Bravo for $6.4bn in 2022. Publicly listed funds overseen by BlackRock and KKR both provided financing to Medallia.
The BlackRock vehicle, identified as BlackRock TCP Capital, during late January significantly reduced the worth of its debt holdings, devaluing its portfolio by 19 percent. Many of its troubled credits were extended to businesses that marketed goods via Amazon, including Razor Group and SellerX, as well as the ed-tech corporation Edmentum.
“All of these holdings were originated in a considerably reduced benchmark interest rate climate and have encountered difficulties adapting to persistently elevated borrowing costs,” Phil Tseng, the principal executive of the BlackRock entity, stated during a conference call with market observers last week.
While a high-ranking official at a competing firm said the BlackRock fund “does not typify the wider private debt sector”, its difficulties have, regardless, echoed throughout the sector, unsettling market participants.
Johnson observed that although the portfolio had been under pressure for a considerable period, “significant poor performance from a BDC associated with a prominent fund administrator is challenging to disregard presently”.
BlackRock’s fund, which has registered an aggregate yield of negative 43 percent during the last twelve months, is exchanging hands at over a 50 percent markdown from its underlying equity. Apollo’s entity, identified as MidCap Financial Investment, carries a valuation 34 percent below its intrinsic worth, while KKR’s FS KKR Capital, is transacted with a 51 percent markdown, as per Raymond James’ analysis.
A tech-focused portfolio overseen by Blue Owl, which previously this year indefinitely suspended withdrawals on one of its funds, has also been being exchanged at a reduced valuation.
“We’re adopting a defensive posture,” said Tim Musial, chief of debt securities at CIBC Private Wealth, which has been reducing its BDC holdings. “You’re just not being sufficiently compensated for taking on risk right now.”
Further contributions from Michelle Chan