ZCG Credit Insights: Double Take in Direct Lending – Update Commentary

A Glimpse of Direct Lending Market Through the BDCs

For the better part of the last two years, we have been vocal about two themes – (1) valuations in the direct lending market were too generous and (2) credit quality was deteriorating beneath the surface. Publicly traded BDC portfolios are now offering some confirmation of that view – with important caveats about what they actually show.

Publicly traded BDCs are regulated and required to report quarterly fair value marks, giving them more visibility than the average direct lending fund. But BDCs are not a clean mirror as manager shave discretion over valuation methodology, so the glimpses are often partial and delayed window into what is happening more broadly across the direct lending asset class.

A What the Narrow Glimpses are Telling Us

BlackRock TCP reported a nearly 20% NAV decline in a single quarter, roughly half of the decline was driven by mark down of six portfolio investments, while the remainder of the damage was amplified by leverage.

At Blue Owl, OBDC II gated investor redemptions after withdrawal requests exceeded the 5% quarterly cap – which ultimately led to Blue Owl selling approximately 34% of its OBDC II portfolioto generate liquidity to meet some redemption requests.

It’s interesting to note that the portfolio of loans that were sold traded at an average price of 99.7%. The implication is that the loans sold were likely among the more liquid andhigher-quality assets in the portfolio, which raises real questions about what remains.

Conclusion

BDCs are giving us an imperfect but meaningful window into the broader direct lending market, and what we're seeing is consistent with what we've been flagging for the better part of two years.

Valuations were too generous, credit quality was deteriorating beneath the surface, and the cracks are now becoming visible.

None of this changes our view that direct lending is an important component of the overall private credit asset class. But it does underscore that manager selection, disciplined portfolio construction, and conservative risk controls are the difference between navigating this environment and being forced to sell your portfolio to meet redemption requests.