Blue Owl’s Omen: The Cracks in Private Credit’s Foundation

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Direct lending: the financings are not the issue

The direct lending sector is encountering some difficulties.

The primary source of the predicament, particularly over the last week or two, has been a particular fund managed by the asset management firm Blue Owl. This fund, named Blue Owl Capital Corp II, was structured primarily for retail investors, providing opportunities for quarterly withdrawals up to 5 percent of its total worth. Such an arrangement differs significantly from direct lending funds for institutional participants, where access to capital may only become feasible after multiple years.

In the previous autumn, the insolvency of First Brands and other missteps sparked discussions of “credit cockroaches,” coinciding with the initial decline in interest rates. These factors combined did not enhance the attractiveness of direct lending as an investment vehicle. BOCCII then started experiencing substantial withdrawal demands and ceased accepting fresh capital inflows. Blue Owl’s proposed remedy involved consolidating it with OBDC, a more substantial, publicly traded fund.

As initially highlighted by my colleague Antoine Gara, this strategy engendered a complication. OBDC, being a publicly listed Business Development Company, is traded at the valuation determined by the equity market. At that specific juncture, its price reflected a 20 percent markdown from the fund’s net asset value (as assessed by Blue Owl). BOCCII, conversely, as a privately held fund, permitted quarterly withdrawals at its net asset value. Consequently, BOCCII investors faced a potential 20 percent impairment upon the integration of their holdings into OBDC. Thus, the optimal action for them would have been to divest at NAV—yet Blue Owl prohibited such an action.

Several days subsequent to Antoine’s report, Blue Owl declared the cessation of the merger and stated that the withdrawal period would resume in early 2026. However, last Wednesday, Blue Owl announced that no withdrawals would occur; instead, the firm intends to distribute investors’ principal intermittently over upcoming quarters and years. A significant portion of its loans has already been divested close to their face value, with plans to reallocate the resultant funds.

This sudden reversal has instilled apprehension among investors concerning the entire sector. Investment firms with direct lending involvement, having already declined this year, experienced additional drops by the close of last week:

The concerns plaguing direct lending extend beyond declining interest rates and lax loan assessments. Furthermore, fund managers have ventured assertively into software financing just as artificial intelligence potentially destabilizes that industry’s future. Nevertheless, the vital insight is that none of these anxieties represents the sector’s root difficulty at present. The underlying predicament, rather, is the erroneous practice of marketing direct lending funds to individual investors.

A significant advantage of direct lending is that creditors can obtain an illiquidity bonus — a greater interest yield — by providing capital to borrowers who prefer to bypass the ongoing demands of the high-yield bond sector. A further, connected benefit is the absence of mark-to-market valuation for these loans, fostering the perception of investment gains independent of public market fluctuations. However, when direct lending instruments are offered to individual investors, some level of liquidity must be provided. This practice, however, generates an inherent conflict, as currently evidenced by BOCCII’s difficulties.

Blue Owl (among numerous others) has sought to resolve this paradox by providing restricted liquidity — specifically, quarterly withdrawals in constrained quantities. Nonetheless, calls for liquidity eventually know no bounds: if even a single individual is informed they cannot exit, then everyone desires to exit, without pausing to evaluate creditworthiness or ponder the genuine effect of AI on the software sector. This sudden exodus will materialize whenever investors discern a significant disparity between a private asset’s “uncorrelated,” “steady” valuation and its immediate market sale price. Yet, the presence of such a discrepancy is precisely one of direct lending’s primary attractions! This inherent inconsistency is untenable and fundamental to the offering.

It is particularly noteworthy that this outcome was widely anticipated. Forecasts suggesting that direct lending offerings aimed at individual investors would result in complications were prevalent from their inception. The fact that these products were nonetheless developed and marketed underscores the formidable influence of Wall Street’s promotional and dissemination apparatus.

Customs Duties: the conclusion of the inception

Financial markets reacted minimally to Friday’s announcement that Trump’s “urgent” customs duties were deemed unlawful. Stocks of businesses relying on imports saw a slight surge upon the news, but this enthusiasm quickly faded. Government bond yields remained stable. The US dollar experienced a small upward shift. This lack of reaction is comprehensible. The Supreme Court’s decision was largely anticipated and already accounted for in valuations. Crucially, moreover, ambiguity surrounding customs duties has not diminished. Indeed, it has likely intensified.

Trump swiftly declared a global tariff rate, initially 10 percent then 15 percent, utilizing section 122 of the 1974 Trade Act, which grants him authority to impose temporary import limitations. Consequently, numerous post-“freedom day” trade agreements and investment commitments are currently uncertain. These arrangements “were dependent on the impending threat of the so-called freedom day tariffs. Should those be invalidated, it is reasonable to expect that our allied nations will seek to withdraw from the ensuing ‘agreements’ that were, frankly, coercive,” states Marcus Noland of the Peterson Institute for International Economics.

The most significant budgetary concern revolves around the question of whether customs duty reimbursements are due, and to whom they should be disbursed. Libby Cantrill of Pimco calculates that the United States has collected approximately $175 billion in tariffs through IEEPA — roughly half of its total tariff income — and, in principle, is obliged to return these funds. These reimbursements will expand the government’s budget shortfall. The Committee for a Responsible Federal Budget projects that the Supreme Court’s ruling and the repayment of customs duties would elevate national debt by $2.4 trillion up to the 2036 fiscal year (this projection predates Trump’s declaration of his 10 percent global tariffs).

For retail and automotive producers, who faced some of the most severe impacts from customs duties, the verdict is unlikely to bring significant alteration. Per Hong from Kearney anticipates that pricing structures and stock scheduling will continue to present challenges. “Numerous entities have already incorporated parts of these duty expenses to safeguard consumer interest, concurrently broadening their supply chains beyond China. Although we await the full unfolding of events, this decision does not reverse these fundamental changes,” observes Hong.

Fiscal unpredictability has consistently represented the primary drawback of Trump’s commercial strategies. The Supreme Court’s pronouncement fails to rectify this. Until enhanced lucidity emerges regarding the revised policy framework and on restitutions, equities, government bonds, and the dollar will persistently contend with the identical adverse conditions encountered since the previous April.

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