Money Stuff: People Are Worried About BCRED Liquidity

Let’s say that you work in private credit and you think that private credit is great. Oh, sure, you’ve seen all the headlines; you know people are worried about SaaSpocalypses and cockroaches and so forth. You just think they’re wrong. You did the deals, you know the credits, and you think that all of these loans are going to work out great and pay back par. How should you trade that thesis?

The obvious intuitive answer is something like: “If people are panicking and want to sell their shares of private credit funds for 80 cents on the dollar, and you think they’re worth 100 cents on the dollar, you should buy them at 80 cents on the dollar.” And then you’ll make 20 cents. Good trade, if you’re right.

But the details here are a bit tricky. Loosely speaking there are about three sorts of private credit funds:

1. There are what you might call “institutional funds,” drawdown funds and separately managed accounts for institutional investors. Stereotypically, the investors in these funds aren’t looking to sell their shares at 80 cents on the dollar: The whole point of those funds is that the investors’ money is locked up for some pre-set period, and the whole point of the investors is that they are institutions who can afford to lock up their money. (In fact there is some secondary trading of private credit fund stakes, but it still seems pretty nascent, and you might have a hard time finding sellers.) Also, these institutions expect their private-assets portfolio to have very low volatility, so if you called them up and offered to buy at 80 cents on the dollar they’d be offended. So this is not a promising way to do this trade.
2. There are publicly traded business development companies, which are retail-oriented permanent private credit funds that trade on the stock exchange. A bunch of those really are trading at 80 cents on the dollar; BlackRock Inc. has one trading below 50. You can just buy them on the stock exchange. This is a straightforward and easy way to do this trade.
3. There are private, unlisted business development companies, retail-oriented private credit funds that are sold by wealth advisers to individual investors and that don’t trade on the stock exchange. The investors in those funds generally can’t sell their shares, at 80 cents on the dollar or otherwise, because the shares don’t trade. Instead, the managers of the funds offer to buy back some of the shares periodically — typically a maximum of 5% per quarter — so that investors who want out can get out. And the managers normally do this at net asset value: If the loans are all marked at 100 cents on the dollar, then the tender price is 100 cents on the dollar.

Most of the bad headlines, these days, are about the third category, the non-traded BDCs, for somewhat intuitive reasons. People who invest in public BDCs that trade at 80 cents on the dollar will naturally be disappointed — they wanted 100 cents on the dollar — but market prices are market prices and you can’t really complain. But people who invest in private BDCs have been asking for their money back, and they are worried that they won’t get it. We have talked about a Blue Owl Capital Inc. private BDC, called “OBDC II,” that stopped doing those quarterly 5% redemptions. And now Blackstone Group Inc.’s main private BDC, called “BCRED,” has gotten redemption requests for considerably more than 5% of its money:

Blackstone Inc. is allowing investors to redeem a record 7.9% of shares from its flagship private credit fund, the latest sign of unease in an industry that’s faced a wave of withdrawals.

The firm is meeting the requests, which are equivalent to around $3.8 billion, by increasing the size of a previously announced tender offer to 7% of the fund’s total shares and by stepping in, alongside employees, to offset the remaining 0.9%, according to a filing and a spokesperson. The fund has around $82 billion of total assets, including leverage, the filing shows.

Blackstone didn’t have to give all those people their money back, but it did, because not doing so would be a marketing nightmare. If a public BDC trades below net asset value, well, that’s life in the public markets. But if a private BDC’s investors ask for their money back, and just don’t get it, they might panic, and the whole retail-private-credit business model might be in danger.

To pay them all out, BCRED didn’t go and sell loans; it raised some new money:

To help weather the withdrawals, the firm turned to old-fashioned door knocking — internally.

The end result: More than 25 senior leaders from across Blackstone — many from its credit business — pitched in some $150 million to the Blackstone Private Credit Fund, according to people familiar with the matter. Combined with $250 million of the firm’s own capital, that helped cover a record redemption request of roughly $3.8 billion, or equivalent to around 7.9% of net assets.

For boring technical reasons BCRED couldn’t pay out more than 7% itself, but “the Board elected to upsize the offer to 7% of shares, the maximum amount permitted without changing the terms of the repurchase offer,” and then Blackstone put $400 million of its own and its employees’ money “into an existing BCRED feeder fund, on the same terms as all other investors, representing approximately 0.9% of BCRED’s shares outstanding.” “Our conviction in BCRED is grounded in its strong portfolio and track record,” says Blackstone.

There is something unsatisfying about this. If you work in private credit at Blackstone, and you think it’s great, and you see outside investors in private credit panicking, and you see private credit fund shares trading at 80 cents on the dollar, and you think they’re worth 100 cents on the dollar, you might want to buy them at 80 cents on the dollar. Be greedy when others are fearful; take advantage of the panic to buy low.

But here Blackstone and its employees are buying at 100 cents on the dollar: The deal, with non-traded private credit, is that it trades at net asset value, even if the market is sending signals that it doesn’t believe that NAV. BCRED redeems panicking investors at 100 cents on the dollar, and it takes in new money — including from Blackstone and its employees — at 100 cents on the dollar, even though there are more sellers than buyers. The market-clearing price, as it were, for BCRED is not its net asset value, which you can tell because the market didn’t clear at NAV. [1]  (There were 7.9% more sellers than buyers, or 7% once you add in the internal buyers.)

The intellectually satisfying and potentially lucrative thing for Blackstone to do would be to say “hey, a lot of you want your money back, and we’d be happy to cash you all out, but at 90 cents on the dollar.” And then supply would match demand and its employees could buy into the fund at a discount.

But Blackstone can’t really do that. For one thing, the legal structure of private BDCs probably requires them to do repurchases at NAV. For another thing, it would be a marketing nightmare to buy investors out at a discount. Part of the OBDC II story is that, last year, Blue Owl tried to merge OBDC II with its publicly traded BDC, which would allow investors to get liquidity whenever they wanted but at market prices. The investors revolted: They didn’t want liquidity at market prices, because the market prices BDC shares at a discount. They wanted their money back, but at net asset value. That, they reasonably thought, was the deal they agreed to in a private BDC, and Blue Owl ultimately called off the merger.

There is just a gap. These private BDCs don’t work quite right; their structure prevents them from trading at market-clearing prices. Presumably if Blackstone could buy back BCRED shares at 80 cents on the dollar it would do that all day long — “our conviction in BCRED is grounded in its strong portfolio and track record,” etc. — but it can’t. [2]

You know who can? We have talked about it before, but I do love Boaz Weinstein’s opportunistic tender offer for Blue Owl’s private BDC shares:

The Purchasers’ tender offers would provide a liquidity solution to retail investors in the wake of a significant industry-wide increase in BDC redemption requests, multiple quarters of net outflows and a rise in redemption gate provisions.

OBDC II, OTIC and OCIC are non-traded BDCs with limited liquidity. Once the 10-business day notice period concludes for each BDC, the Purchasers intend to announce the commencement of the tender offers to provide direct liquidity to investors who seek it, subject to terms and conditions and the number of shares to be purchased that will be detailed in tender offer documents, including the offer pricing and number of shares covered by each offer. The offer price is expected to be at a 20-35% discount to the most recent estimated net asset value and dividend reinvestment price, as applicable for each BDC, which will be determined when the tender offers are commenced. The Purchasers are not affiliated with OBDC II, OTIC, OCIC or their advisor.

People seem to want out of these private BDCs, they are worried that the BDCs’ sponsors might not cash them out, and they might be willing to get out at a discount. The sponsors are doing their best to cash them out, but they can’t cash them out at a discount. But Weinstein can! Might as well try.

A very funny trade would be if Blackstone tendered for some Blue Owl BDCs at a discount, and Blue Owl tendered for some Blackstone BDCs at a discount, but it is not hard to see why that won’t happen.

The basic way that corporate debt works is that a company gets some revenue, and then it pays its necessary expenses, and then it pays its debt out of what’s left over, and then if there’s money left after that it can spend it on new investments or frivolous expenses or executive pay or stock buybacks or whatever. So if a company has $100 of debt and makes $400 of revenue, it might spend $250 on salaries and rent and utilities and all the other stuff that is absolutely required to keep the lights on and bring in that revenue, and it will have about $150 left over. And it will send $100 of that to its creditors and keep the other $50 for whatever its executives and shareholders want.

That is a very fuzzy description, though. Usually the way debt works is that, when a company borrows money, it won’t have to pay that money back for several years; it will make interest payments along the way, but those will be much smaller than the principal of the debt. If, during the intervening years, the company mostly squanders its money, then when the debt comes due it won’t be able to pay. Everyone understands this, so the debt will probably contain covenants prohibiting the company from squandering the money too egregiously, but this is hard to measure and in fact companies often do go bankrupt and default on their debt.

You could imagine formalizing the fuzzy description from my first paragraph. When it wants to borrow money, the company could sit down with its lenders and agree on an explicit flowchart for its revenue:

• The first $X of revenue every month goes to pay necessary expenses to operate the business. X is fixed; the creditors and the company agree on what the necessary expenses are and how much they will be. The company doesn’t get to change its mind later; it can’t decide to get into new business lines and increase the expenses it deems necessary. The necessary expenses are just fixed in advance for the life of the loan.
• The next $Y of revenue goes into a box to pay down the debt over time. The creditors don’t have to wait seven years to get paid back; the money flows back to them each month.
• Anything left over goes to the company for new investments, frivolous expenses etc.

This is, in general, kind of a bad way to run a big company, and most companies want more flexibility than this. But for certain sorts of companies with pretty stable revenue and expenses, this can work. For instance, restaurant brand companies — which make steady revenue from franchise fees and have reasonably straightforward management expenses — sometimes do deals like this, which are called “whole business securitizations.”

Just the words “whole business securitization” sound terrible. The theory of a whole business securitization is that (1) you can borrow money secured by your whole business but (2) that debt is safer — it should get a better credit rating and a lower interest rate — than regular corporate debt would be. Because you fix your expenses and put your revenue in a box, and your lenders buy bonds of that box, they are getting a different, better proposition than just buying bonds of your company. The box has more reliable cash flows and is more protected from your bad business decisions, so it is safer and the debt should cost less. [3]

I have never entirely been able to get my head around this. It just sounds like a trick that shouldn’t work. It is one thing for a company to take some stream of steady cash flows, put it in a box separate from the rest of the company, and sell bonds of the box with high credit ratings. But here the company takes all of its cash flows, puts them in a box separate from … nothing?, and sells bonds of the box with high credit ratings. Unsatisfying.

Anyway Bloomberg’s Soma Biswas and Scott Carpenter report that FAT Brands Inc.’s whole business securitization is unsatisfying:

Whole business securitizations repackage a company’s revenues and channel them to bondholders. They’re billed as bankruptcy-remote — able to withstand a borrower’s Chapter 11 because bond payments are ring-fenced.

But in the case of FAT Brands, $1.4 billion of bonds are supported by just $40 million in annual earnings before interest, taxes, depreciation, and amortization, according to court filings.

That apparent shortfall is stirring speculation that creditors including Barclays, Brigade, Angelo Gordon and Bracebridge will suffer losses on a securitization that gives them first dibs on FAT Brands’ earnings. ...

FAT Brands, which operates chains including Johnny Rockets and Fatburger, is the latest casualty of budget-conscious consumers who are eating out less. Its bankruptcy follows Chapter 11 filings by Hooters last year and TGI Friday’s in 2024. Like them, FAT Brands pledged virtually all of its earnings to a debt structure that became too much to bear.

Just intuitively, if a company files for bankruptcy because it doesn’t make enough money to service its debt, and that debt is both (1) secured by the whole business and (2) “bankruptcy-remote,” you have to worry a little bit. Remote from what? The debt gets paid out of the revenue from the business; if the revenue from the business isn’t enough to pay the debt, then legal structure isn’t going to help you that much.

FAT Brands filed for bankruptcy in January; here is its first-day declaration, explaining that the money set aside to pay necessary expenses — the “$X” in my schematic description — is not enough to keep the business going:

The Management Fees are paid near the top of priority waterfall to provide the Managers with the funds to provide integral centralized functions that enable the Securitization Entities and their brands to operate and generate revenue. However, while the quantum of such fees should at minimum ensure that the Managers can cover the costs of operating the underlying assets of the Securitization Entities, the funds received from the Management Fees generally have not covered the actual operating costs of the businesses.

And here is an angry motion from its securitization bondholders saying that “the Debtors’ first day pleadings are a fairytale, in which a well-intentioned parent company tried valiantly to provide essential services to the separately securitized subsidiaries that it managed even though (for some unexplained reason) it did not have sufficient cash to do its job”:

In truth, the Debtors’ operating businesses, which are separately financed and securitized, generate sufficient income to support their basic operating expenses. And the agreed management fee should be sufficient for the parent company to provide the management services to support the securitizations. That is how the system is designed to work. The reason these Debtors are short on cash is because [FAT Brands Chief Executive Officer] Andrew Wiederhorn looted them to support himself and his family. 

You can agree in advance on how much money you need to run the business, and set aside the rest to pay bondholders, but sometimes you’ll get it wrong and still end up with disputes over what expenses are necessary.

Yesterday I sort of argued that the problem with the modern US retirement savings system — in which most people have “defined contribution” plans, like 401(k) plans, where they manage their own investments — is that it requires too much liquidity. A big pooled pension fund can invest for the long term, because while some beneficiaries will need money sooner than expected, in the aggregate the fund’s expenses are pretty predictable. But if you run your own retirement savings, you probably won’t need your money until you’re 65 or so, but events come up, it’s hard to be sure, and you’ll want to hedge your risk by demanding more liquidity from your retirement investments than would really be optimal. Which is bad for, you know, BCRED.

In that vein, the Wall Street Journal reports:

More Americans are digging into their retirement savings because of financial emergencies.

Last year, a record 6% of workers in 401(k) plans administered by Vanguard Group took a hardship withdrawal. That is up from 4.8% in 2024 and a prepandemic average of about 2%, according to Vanguard.

The data paint a divergent financial picture of American workers’ finances. While most are faring well, some are experiencing heightened financial stress, according to Vanguard.

Workers have been saving more in 401(k)s, and balances have soared to all-time highs along with rising markets. With more people saving in 401(k)s, retirement accounts are an increasingly important lifeline when financial trouble hits.

If the main way you save for retirement is in an account that you manage, with a dollar balance that you can check every day, you might end up spending those dollars before retirement.

You know the drill: Every bad thing that a public company does is, arguably, also securities fraud. If the company’s senior executives do something you don’t like, you can sue and say that it’s securities fraud. The company probably said something to the effect of “our senior executives are ethical,” and they weren’t; the company didn’t fairly warn you that the executives were doing the thing you don’t like. Etc. 

Jeffrey Epstein was bad. These days, it is bad for business to have been pals with Jeffrey Epstein. Quite a few public company executives were pals with Jeffrey Epstein. The lawsuits write themselves, though I think this is the first one I have actually seen:

Shareholders sued Apollo Global Management and its billionaire co-founders Leon Black and Marc Rowan on Monday in a proposed class action for ‌allegedly defrauding them for nearly five years about the private capital firm's business dealings with disgraced sex offender and financier Jeffrey Epstein.

According to a complaint filed in Manhattan federal court, the shareholders alleged the defendants falsely denied in several regulatory filings in 2021 and 2022 ever doing business with Epstein, though Epstein “was heavily involved and frequently communicated with Apollo Global's senior leadership” about Apollo's business during the 2010s.

Here is the complaint. I should add that it is a bit too simplistic to say that, if a company’s executives do something you don’t like, you can sue for securities fraud. Your damages, in a securities fraud lawsuit, will be tied to your losses as a shareholder, which means in practice that you can only sue for securities fraud if (1) the company did something you don’t like and (2) the stock went down when the thing was revealed. [4]  The more the stock went down, the more lucrative the lawsuit might be.

Here, the complaint says that Apollo lied about the extent of its Epstein ties, but “the truth [began] to slowly materialize and emerge through partial disclosures” beginning on Feb. 1. And in fact, Apollo’s stock is down almost 20% since the start of February. Is that because of what the market has learned about Apollo’s Epstein ties? Well. Some other stuff is going on, in the alternative investment management space. Blackstone Group Inc., KKR & Co. Inc. and Blue Owl Capital Inc. are all down more than Apollo during that period. There will presumably be some arguments over loss causation. But “Apollo had some Epstein ties, they came out and the stock dropped 20%” is a pretty irresistible combination for a securities class action lawyer.

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