Re-fund? No thanks.
Private credit is having a moment. Not the kind of moment that the industry would like, but oy it is hard to escape reading or hearing about it. I’ve written several times about the threats to the industry (here, here and here, for example), so I won’t repeat those words, but as we watched this week, a new-ish threat was discussed: funding.
Funding isn’t as sexy as trading or portfolio management, so it isn’t talked about as much. But like many boring aspects of finance, it is critical to the function. The best source of funding is revenue, but to get started, and to make big leaps of growth, an asset manager needs to pick up the phone and raise funds that can then be invested. If you’re rich yourself, or have a lot of rich people in your network, then accessing the funds to invest can be relatively easy. If you have an amazing track record of generating above average returns, you can get first dates more easily with people who have money. Being famous or a successful pro athlete also helps.
But if you’re an asset manager who has raised money and wants to grow, or (shudder) your company is public, then there is an expectation that you will grow, with major financial consequences if you don’t. So you have to keep raising funds. If net income is high and rising, you can re-invest those earnings as new loans, and the virtuous cycle continues. If you need to go outside the company for funds, in good times you can go to the existing investor base to use that dry powder, or get them to write new cheques. If that’s not possible, there may be other investors, but if they’re not around, you turn to lenders. Banks have wanted to get into the private credit space, and lending funds to existing private credit managers is a faster path than setting up your own business line. Some smaller banks in the USA have outsourced significant chunks of their lending activity to private credit companies, to reduce overhead and regulatory risk.
Investors started pulling back in 2024, so companies like Blue Owl had to start raising funds from lenders, and given their share price at the time and successful brand, the banks were willing. But now the banks are getting skittish, and with private credit’s reputation getting bruised (just read the Financial Times or Bloomberg’s coverage these days), fewer lending alternatives are available. The middle east used to be a great source right up to last month, but Trump’s war with Iran has made it much less of a sure thing.
So if there’s no funding, then companies like Blue Owl can’t keep the growth treadmill running. And if their existing investors want to pull out, then Blue Owl has to find the cash to pay them back. This cuts into net income, and reduces their asset base, which is bad for the share price, which causes anxiety amongst their shareholders, so they start selling, and a much less virtuous cycle starts.
This is why when Blue Owl’s co-CEOs talk about how safe the company is, I frankly don’t believe them. They could still have a great portfolio, and lots of cash on hand, but when everyone wants out, both will be depleted in a hurry. I’m currently re-reading “Too Big to Fail”, and the section about Morgan Stanley going from cash-rich to having five days of cash on hand is harrowing, and must have been sickening to live through. If your company isn’t living on its retained earnings, it can happen to you too.
We are living in the most surreal times: one blog post spooks the markets, another hands IBM its biggest daily loss this century. Last month an analyst said that the belief that the market is overvalued is so prevalent that any bad news is being treated as the straw that will break the camel’s back. And now we have war in the middle east, which threatens not just the energy supply chain, but the latest hot spot for obtaining funds (that’s Middle Eastern sovereign wealth funds). The potential for rising costs in the USA means that the most likely direction for interest rates is up, not down, increasing the crimp on credit.
Blue Owl closed Friday at $9.89, down over 50% from its 52 week high. Given the above factors, I don’t think it will survive this year as an independent company. It will either be acquired, or exit the scene entirely. And when that happens, the market will look for the next-weakest lender.