More private credit managers may follow in BlackRock’s footsteps and choose to cap exits from their semi-liquid funds at the stated 5% of net-asset-value limit if the surge in redemption requests continue over the coming quarters, according to Chelsea Richardson, senior director for non-bank financial institutions at Fitch Ratings.

“If [high redemption volumes] continue, there will be a point where it kind of negatively impacts leverage and liquidity more than what the BDC planned for,” Richardson told Creditflux. “There does need to be a limit to prevent a run on those.”

Perpetual nontraded business development companies, which have raised billions of dollars from affluent US individuals over the last few years, are facing their first major test as exit requests surge. At some of these semi-liquid direct lending funds, redemption requests have exceeded the quarterly liquidity limit that the product is designed to offer. Regardless, most managers have chosen to fulfill the additional exit requests.

Last week, BlackRock bucked the trend by becoming the first major fund to stick to the 5% limit, preventing some shareholders in its HPS Corporate Lending Fund from exiting their investments in full.

Affluent individual investors seeking higher yielding fixed income options flocked to perpetual nontraded BDCs starting around 2021, resulting in these relatively untested vehicles corralling more than USD 226bn in the span of a few years. The perpetual nontraded BDC was heralded for providing exposure to illiquid direct lending assets while maintaining share price stability. Rather than trading on an exchange like its listed BDC cousins, these vehicles typically accept new commitments periodically and offer some limited liquidity on a quarterly basis by repurchasing shares at NAV. Now, as direct lending yields decline and credit quality concerns mount, investors rush to exit.

Despite redemption requests exceeding the 5% mark at several funds now, most perpetual nontraded BDCs have opted to fulfill all requests by expanding the share repurchase programs. Blackstone, which saw exit requests reach 7.9% in the first quarter, upsized its liquidity program to cover all redemption requests, as previously reported. The alternative investment giant pulled a similar move in 2022, opting to fulfill all liquidity requests when redemptions hit the 5% cap for the first time.

Of the perpetual nontraded BDCs tracked by Fitch, five vehicles recorded redemptions totaling above the quarterly cap of 5% of NAV during the fourth quarter, as previously reported. Blue Owl Technology Income Corp saw the highest redemption requests among its peers, with redemptions exceeding 15% of shares outstanding, according to Fitch data. Ares Strategic Income Fund, Carlyle Credit Solutions, North Haven Private Income Fund and Blue Owl Credit Income Corp all also saw redemptions exceed the 5% cap. All five perpetual nontraded BDCs fully funded investor requests rather than capping the liquidity offering.

“We’ve seen these one-off quarters where some BDCs have gone above the 5%, really just driven by the leverage capacity and the excess liquidity that they have,” Richardson said. “I think they’re kind of evaluating it every quarter.” Especially in cases where the redemption requests just modestly exceeded the 5% limit, the funds probably felt they had plenty of liquidity and leverage to allow all exits while keeping an eye on what redemption requests will look like the following quarter.

For many, the fourth quarter was the first time redemptions hit the 5% limit. Given industry concerns about credit performance and such, some management teams likely felt it was prudent to allow all exits to reassure investors and show there were no major issues at the funds, Richardson said.

“We did see that [BlackRock’s perpetual nontraded BDC] is capping at 5%, and our expectation is that we will see more of that if redemptions remain elevated across the sector,” Richardson said. “Because that is ultimately the way that these vehicles were structured, and I think the BDCs intend to manage them that way.”

Perpetual non-traded BDCs primarily invest in illiquid private credit assets that often cannot be quickly sold without potentially harming value, necessitating a liquidity limit. The 5% cap helps to balance long-term investing with some level of investor liquidity by protecting the portfolio from forced sales, which could lead to unfavorable prices, according to Sasha Burstein, partner at K&L Gates. It also ensures fairness among shareholders by preventing a situation where early redeemers receive full liquidity at the expense of investors who remain in the fund.

A fund could hold more cash to meet redemptions beyond the 5% limit, but this comes at a trade-off. Holding more cash over the long-term rather than investing it into new illiquid loans hurts dividend coverage and returns, according to Richardson. The fund would miss out on getting yield generated by new investments.

The quarterly liquidity limit is a feature of the perpetual nontraded BDC rather than a bug, Burstein said. The ability to invest in less liquid private credit opportunities, which can offer attractive yields, depends on funds having predictable and manageable redemption levels.

“If a fund regularly exceeds its designed liquidity limits, it could ultimately pressure the portfolio or require changes to portfolio management decisions,” Burstein said.  “That’s why many perpetual BDCs include the 5% limit.”