Private credit faces another explosion! BlackRock "rarely" waives management fees as its private credit fund performs poorly

According to media reports on Thursday, a private credit collateralized loan obligation (CLO) under BlackRock failed to pass a key test due to deteriorating asset quality, forcing the world's largest asset management company to take the rare step of waiving part of its management fees to alleviate the default situation. This incident has sounded the alarm for the rapidly expanding private credit market.

In October last year, the CLO named BlackRock Baker CLO 2021-1 failed to pass the over-collateralization test due to a decline in portfolio value. This test measures the ratio of the value of loan assets to the highest-rated bonds, and failing to meet the standard indicates that the asset value is too low relative to the bonds. According to insiders, BlackRock helped rectify this default by waiving management fees, including cash from the highest-risk tranche bonds.

This CLO, with a size of approximately $495 million, holds loans from several distressed companies. These include home renovation company Renovo Home Partners, which filed for bankruptcy earlier this month, as well as education software provider Pluralsight Inc., which was taken over by private credit institutions last year, and Astra Acquisition Corp., which filed for bankruptcy in September last year.

This incident comes at a time when the private credit market is showing signs of fatigue. Blue Owl Capital halted the merger plans of two of its private credit funds on Wednesday, following a sharp decline in its stock price due to concerns raised by potential investor losses.

Rare Over-Collateralization Test Failure

For high-rated bonds of CLOs, failing to pass the over-collateralization test is uncommon. These products have long been viewed as resilient due to their self-correcting mechanisms—when a test fails, the system automatically shifts interest income from high-risk tranches to safer bonds.

However, the issues with BlackRock's CLO are not new. According to data compiled by Bloomberg, this CLO's high-rated bonds first failed the over-collateralization test in October last year and have since oscillated between repair and failure multiple times. The highest-risk tranche bonds of this CLO have continuously failed the test since April 2024, prompting S&P Global Ratings to downgrade the ratings of the D and E tranche bonds of this product in December last year, citing "deterioration in the credit quality of the underlying portfolio."

According to a report from trustee Wilmington Trust, this CLO, issued at the end of 2021, was launched during a hot period in the private credit market. At that time, well-funded funds engaged in fierce competition for loan business, abandoning key safeguards and significantly increasing leverage—this risky behavior amplifies problems when companies face distress.

Concentration of Problem Loans

Several loans held by BlackRock Baker CLO 2021-1 have already encountered serious issues. According to previous reports by Bloomberg, BlackRock had valued its private debt to Renovo Home Partners at par value of 100% just weeks ago, but quickly marked it down to zero after the company filed for bankruptcy.

The CLO also holds loans to Pluralsight Inc., which was taken over by private credit institutions last year. Additionally, according to trustee reports seen by the media, this CLO also holds debt from Astra Acquisition Corp., which filed for Chapter 11 bankruptcy protection in September last year BlackRock's predicament is not an isolated case. The company’s recent acquisition of HPS Investment Partners has written down approximately $150 million of debt owed by companies under businessman Bankim Brahmbhatt to zero, which are currently facing fraud allegations and federal investigations.

Market Concerns and Structural Risks

Although other middle-market CLOs under BlackRock, including TCP Waterman and TCP Whitney, have performed well, this incident has raised questions about the broader outlook for the private credit market.

Recently, the credit market has been impacted by the collapse of subprime auto lender Tricolor Holdings and auto parts supplier First Brands Group, leading to public accusations among Wall Street executives regarding lax underwriting standards.

The private credit CLO market continues to expand rapidly. According to Bank of America research, private credit CLO issuance has reached approximately $34 billion year-to-date, expected to surpass the record of $39 billion set in 2024. The bank anticipates that, in the long term, about a quarter of direct loans may be held by CLOs.

According to data compiled by Bloomberg, BlackRock has approximately 29 products in the broadly syndicated loan-supported CLO market, which is expected to set a record for issuance this year. It remains unclear whether the predicament of this CLO signals deeper issues in the credit market, but its performance undoubtedly casts a shadow over the rapidly expanding private credit market