Beyond 60/40 Ep. 46: Blue Owl on Private Credit Resilience

Recent headlines have raised tough questions about private credit—defaults, liquidity concerns, and valuation practices. In Episode 46 of Beyond 60/40, Sonali Basak, iCapital’s Chief Investment Strategist, sits down with Craig Packer, Co-President and Head of Credit at Blue Owl, to unpack the facts behind the noise. Craig shares insights on credit quality, the role of private equity sponsorship, liquidity expectations for BDCs, and why portfolio construction matters more than ever. 

Topics Covered: 

• Why recent defaults are isolated, not systemic 
• The paused Blue Owl BDC merger and what it really means 
• Liquidity expectations for non-traded BDCs 
• How valuations are determined and why transparency matters 
• What investors should expect as interest rates shift 

Watch now to understand the fundamentals driving private credit’s resilience and what investors should know before allocating capital.

Transcript

transcript Beyond 60/40 EP 046, Craig Packer, Blue Owl

Sonali Basak:

I'm Sonali Basak, the Chief Investment strategist at iCapital. Welcome to the latest episode of Beyond 60/40. And today we're gonna tackle one of the biggest topics in private markets today. Perhaps none bigger of a question than private credit. And we are joined by the perfect person to talk about it. That is Craig Packer. He's the co-president and head of credit at Blue Owl. Craig, thank you for joining us. There has been so much news around the private credit industry. Let's start to unpack some of it.

Craig Packer:

Sure. Sonali thanks. Thanks for having me. Thanks for doing this.

Sonali Basak:

So, on the question of credit quality, I think we have to start there because we go back a couple months through the end of 2025. We have seen some hiccups in the world of private credit, but really a lot of those defaults that we have seen are not purely private credit. They've been very confusing to people. Yeah. And it's created this massive question on how many problems are there really in the broad ecosystem of private credit.

Craig Packer:

We manage about a hundred billion dollars of direct lending out of about $150 billion private credit book. And I have to tell you, the credit performance continues to be very strong. And if anything, I would say a bit better than we might have feared at the beginning of the year, beginning of the year. There's a lot of worry about tariffs, recession, actually. The economy continues to hold up very well. But I also think it speaks to the sectors that we lend to. We intentionally lend to very non-cyclical sectors, healthcare, software, insurance, brokerage, and generally those are continuing to perform very well. You're right, there've been isolated stories of companies that have had problems and investors are worried. Is there more to come? I would say we're not seeing in our portfolio, and I don't expect it in the large players that we compete with every day we have a good sense of what's in their book. We expect credit performance to continue to be very good. 

Sonali Basak:

Well, that's so interesting you say that your own book and even some of your peers, you're getting some transparency into what's happening there. Frankly speaking, there have been some losses that even some of the larger, more well-established names have been privy to. How can you explain what's going on there? Because I think the big learning here is credit is not a riskless proposition. There will be losses, 

Craig:

of course. 

Sonali:

So how do you think about what those losses are?

Craig Packer:

Yeah, look, I think part of it, you have to look at are you investing in a really high quality manager and what risk profile are they seeking? Are they seeking, um, the highest quality, but they're sacrificing some return? Or are they willing to stretch on credit risk? Um, if they're willing to get higher, uh, higher return. Um, I would caution investors, people tend to be, look, private credit's grown a lot. There's a lot of attention paid to it. To your point, people want to understand, are there more problems to come? Portfolio construction is really important, with lending. Our returns are capped. We're gonna get back par if things go as according to plan. And so we really focus on diversification. The average position size across our credit platform is about 40 basis points. A high quality manager is gonna have a lot of names with very small size. And so I would just caution investors, when you read about one deal, two deals, you have to put it in the context of what portfolio is in. Is that investment going to have an outsized impact on returns? We weren't in any of the deals that had problems, but I would say in general, they're very isolated and they're, if the portfolios were well constructed, they're not going to have an outsized impact on the returns in those portfolios. The last point I'd make, and I think it's an important one, um, our biggest business is, as I say, uh, direct lending, which is a part of private credit. Private credit's a very big, uh, umbrella in direct lending. We're primarily lending to companies backed by private equity firms. We think that's a very, um, uh, important aspect of what we do because that means that there's another institution that's investing typically more than 60% of the capital structure in equity beneath our loan. That has another set of eyes in the ears and expertise to look over the companies. Some of the problems that have happened have been companies that don't have that private equity backing. We do non-sponsored deals, so I don't want to, I don't want to paint it with a complete broad brush, but, um, I think that this is showing the strength of lending the sponsor backed companies, um, that continues to be something that's a great downside protection.

Sonali Basak:

Okay. We'll talk more about credit quality. We'll talk more about private equity in particular. But first I wanna kind of go backward because recently you had attempted a merger of two business development companies. These are private credit vehicles, very different in the way they were structured. But what had happened was you called off the merger citing market market conditions, and there were a lot of questions in the market about what does this mean? Is the credit quality bad? Why are they gating the fund? How would you describe what exactly happened there? Sure.

Craig Packer:

First, there's no fund that was gated. Um, uh, look, I think that, that this whole incident, again, speaks to just a lot of interest in, in private credit. And I love having these opportunities to unpack this a bit because people are just reading a headline or two without really understanding what happened. [05:20] t's, it's a fairly simple story. Uh, the fund that has gotten the attention was the second fund that we raised in the history of the firm. Raised it about 10 years ago, OBDC two. Um, the first fund we raised was OBDC, which are publicly traded. B-D-C-O-B-D-C two is very similar to one in terms of, its, its portfolio construction. The names, there's a 98% overlap. Um, but OBDC two was raised with an old fund structure. Um, today we have what's known as perpetual non-traded BDCs. Those funds are designed to stay private forever. O-C-I-C-O-T-I-C. Those are our two perpetual non-traded funds. Um, investors can invest in them at any time. They're, they're designed to stay private. OBDC two was different. We raised it before that technology was developed. And we, we developed that the new perpetual technology. This fund had a defined life and it had a stated goal of a strategic transaction at some point that would provide investors a path to full liquidity. We've been doing tender offers every quarter in the history of the fund. We've met all those obligations. But there was a stated timetable that, that we said, we're going to eventually return all the capital. And so this transaction was a fairly mundane, uh, way to affect that. By merging a two funds, the smaller fund into a bigger fund, the investors in that fund would've gotten been in a vehicle 10 times the size with 150 to 200 basis points, higher dividend yield. Um, we've done this a couple other times. It's all worked very clearly and cleanly. And we thought this was a good plan for investors. However, the publicly traded stock BDCs generally, not just us, but BDCs in general, had traded down. And so at the time, soon after we announced the deal on paper, it would look like you're trading from a private fund into a public fund that's trading at a big discount. And that got a lot of attention, a lot of confusion. Um, we didn't have to do this transaction right now, so we decided, you know what, let's clear up the confusion and let's just pull the transaction. And we're, we're now gonna work with our board to figure out what's the best way to complete our strategic objectives of the fund.

Sonali Basak:

Right. So the OBDC fund that is not traded.

Craig:

 Mm-hmm. 

Sonali:

There's a, there's a lifespan to it. There's something that has to be done with the finite amount of time. And it seems like you have guided investors to that eventuality for a long time now. Yes. But what I'm kind of confused about here, I'm wondering how much of this is the fund structures are changing, right? These perpetual vehicles you don't need to do. Yes. A transaction like this, these older vehicles that people might have bought eight, 10 years ago, however many years ago for these older vehicles, they kind of put their money in, they set it and forget it, and they didn't think about what was going to happen at the end of the lifespan. That feels to me a little bit of what happened here. Um, would you agree with that?

Craig Packer:

Uh, well, I, I don't agree with it in the sense that I think most of the confusion has come from people that aren't investors in the fund. <laugh>. I think the investors in the fund have had a terrific experience. They've got about a 9% return. Credit performance is very strong. We've been making our distributions every quarter. We've been satisfying our redemptions every quarter. We have said publicly multiple times that at some point it would make sense to merge this fund potentially into OPDC. No guarantees. So investors that have been invested in the fund, um, shouldn't be, have been surprised by this being a possibility. It was the most likely possibility. Um, however, you know, I would say one thing that caught a lot of attention is when we announced the merger, we paused the quarterly tenders for the quarter while we're in doing the actual merger. Um, that's the way to deals like this are typically constructed. Um, you're doing a shareholder, this deal is subject to a shareholder vote at OBDC two. So we're giving investors a choice, completely their choice. We thought they would prefer this outcome. But during that voting and merger process, we paused the tender. And I think that fed into some of the other questions in the industry that had nothing to do with this particular fund, which is the inherent illiquid nature of the investments. So it got caught up in all that noise. Um, and so investors in this fund, again, it's performing very well. Our timetable for solving this is measured in years, not quarters. Not months. And so we're gonna patiently sit down, come up with, alter a better alternative and work on getting the investors, you know, the full liquidity that, that, that, uh, that we promised them. 

Sonali Basak:

Yeah. What's the most likely outcome from here now that the merger has been scrapped?

Craig Packer:

I don't wanna get into too much detail because again, we have a long timeframe. You know, I don't wanna disappoint everyone, but you shouldn't, you know, expect tomorrow morning you're gonna read with a new transaction. you know, I've seen some articles saying, we're gonna revive the merger back into OBDC. It's highly unlikely that we would do that. Um, but we're gonna keep everything on the table and talk to our board, um, and work through this in a careful way. Again, the fund continues to make its distributions. Um, we've said we're gonna resume our tender offer in the first quarter. it's a relatively small fund. This fund is less than 1% of the assets of our credit business. and it's performing well, and we'll figure out the best alternative to return the capital. But again, we are investing in loans. They contractually make interest payments and they contractually mature. And essentially, one way or the other, we're gonna take that capital and return it to the investors.

Sonali Basak:

So it's interesting because I, in the process of all of this, I had my team go back and look at every BDC merger that has happened over the last several years. And to your point, it's actually very interesting. A lot of them actually do pause tenders. This is actually not all that uncommon. And BDC mergers have, at least as we've seen it, have actually tend to been, uh, have been a feature rather than a bug of the market. But I think it says something interesting. You started saying this about liquidity and the understanding about liquidity in this space. We talked about credit, and now I think it's really time to understand the liquidity profile. What should investors know about BDCs before they get into them? The world of private credit and how liquid it actually is or isn't? 

Craig Packer:

Yeah, well, first I applaud you for having your team go back and do the actual work on, on other deals. You know, I can assure you not only with our board, but the outside law firms, you know, this was a very carefully considered transaction, structured in a way that was very standard for the market. Um, but to your point, and I, again, I really appreciate the chance to, to have this kind of conversation. We invest in illiquid assets for the most part. There's no market in them. And if you're going to be investing in a large portfolio of illiquid assets, it's critical that your capital base matches that illiquidity. Investors need to understand this. If you need to be an investment that offers complete liquidity, then a large private non-traded BDC, it's just not for you invest in a mutual fund, you'll have complete liquidity every day. It's a better product. Now you're gonna sacrifice meaningful returns for doing that. That's the trade off. If you wanna, if you have a long-term time horizon, like many of our clients do, they're not investing in this to get their money back in a year or two. They want the income. Much like institutional investors that have in time horizons measured in 10, 15, 20 years, these funds pay 90 plus percent of their income out in dividends every quarter. That's the primary reason investors invest in the funds. You're gonna get that income. That's obviously just some measure of liquidity. It's quite substantial, depending upon the yield environment. That's a high single digit, low double-digit return. Typically, um, our non-traded funds and the industry standard every quarter, we tender for 5% of the equity of the fund. That is designed to give investors that have to sell for some reason,

Sonali Basak:

Rebalancing, taxes, gifts, all sorts of potential reasons

Craig Packer:

The state, you know, some, something happened in, in their lives. They, they need the money back, you can submit. And five, we're tendering for 5% at OCIC, our largest fund. You know, we've never exceeded that 5% threshold. Every investor, every quarter in the history of the fund has gotten whatever they wanted out in the tender offers. And that's going to, uh, continue those tender offers. Um, and so that is the path to investors' liquidity. That's how it's worked. That's how these products are designed. So I would say to investors, if what you're looking for is a long-term investment that's gonna generate stable income, um, and that at some point, if you need your money back, you can get it through the tenders. It's a great product. If what you wanna make sure is, I want make sure that I can get all my money out at any point in time, you know, this probably isn't the product for you. And, but it should be a part of a portfolio. It's not meant to be half your portfolio.

Sonali Basak:

So when it, you think about liquidity, because more and more types of vehicles are coming out with different liquidity features 

Craig:

mm-hmm <affirmative>. 

Sonali:

Now there's a big question around what the meaning of that liquidity is. How much of a return drag does it create because it is more liquid or even, you know, should there be liquidity? And to your point that you were making earlier for assets that are I liquid? Right? Yes. You know, what do you make of an industry that's trying to become more liquid?

Craig Packer:

For the most part, the products in the private credit space that we're talking about are structured with very modest liquidity. If they're primarily invested in, in illiquid assets, I think that's the right way to structure them. Um, I think that this incident with our merger and the headlines, I think has actually in some ways been a good, um, reminder to investors understand the liquidity of the fund that you're in and make sure it matches up with your, with your time horizon. Um, I know that some managers have products that might have different profiles. They're offering more liquidity. As long as the assets that are in the fund are liquid, then there's a good match there. You certainly don't want to be in a fund that's offering lots of liquidity, but inherently in illiquid assets. I'm not aware of any investments like that. I think for the most part, there's a good match. I think the industry, um, is, is generally on solid footing. Um, and, but there are gonna be times where this gets a spotlight. Investors want to make sure they understand, what am I in? Why am I in it?

Sonali Basak:

You know, it's interesting. On one more on liquidity before we go back to credit quality, because, you know, you mentioned that the non-traded BDC was in an old structure, one with a finite lifespan. Now these perpetual structures, uh, people are really interested and excited about evergreens in the world of private credit. But what happens as this space changes, really, what does it allow for? Um, how will this change the type of interest that's in the space? How will the liquidity profile of these vehicles change? I think it's technology, to your point.

Craig Packer:

Yeah. I think that the, that the perpetual non-traded funds that, you know, again, we were a pioneer in this space. They've been incredibly well received. That's why we're here. Right? They've grown a lot. There's a lot of more capital in the space why investors like it to begin with. They like it because it generates a very predictable amount of income and they have longer time horizons. I think that sometimes, um, folks maybe underappreciate just the basic thought that, um, uh, investors, clients, we have clients that you work with every day, actually have to plan their future. They want the income, and they actually find it a positive that it doesn't trade. Because many investors don't like the volatility of the public markets. and so they find the fact, you know, we redeem when we do our tenders at book value. Um, we can talk about the mark process. I’m sure….

Sonali Basak:

 that's exactly where I was going to go next.

Craig Packer:

Just tried to leave it, leave it up for leave it up there. That's an important part. But we're redeeming at book value. Um, and with a proper portion of your portfolio, I think it has the right liquidity profile to deliver consistent income with periodic redemption rights.

Sonali Basak:

You know, it's interesting, there's so much to get to here, but mark, Marx, I really believe will be a defining conversation in 2026. And the reason is this, you've seen a few high-profile cases of some large fund managers having to mark things down quickly, sometimes even from a hundred to zero. Uh, you've seen instances where you've seen a spread between what different managers are holding assets at. And you've even seen, you know, I draw back to the Jay Clayton comments. You might've seen them recently too. He was in the industry, right. In many ways and still is looking at it as a, uh, a traffic cop in this space now. Right? So how do you think the Marx conversation is gonna play out? And do you think that there needs to be a change in the methodology of how this industry goes about it?

Craig Packer:

let me just give you a brief description of how we do it. And I think we're, I think many firms, but not all do it similarly. Um, I think marks are important. You should understand how your manager marks their book. If you don't understand you, you should ask them. For us, we've been very clear. We've done it the same way in the 10 years we've been in business. We mark every name, every quarter, and we use an outside firm that holds the pen on that valuation process. They do a tremendous amount of work on each name. Um, in the book, obviously, our team gives them a lot of information to be able to make those judgements. They pick a valuation. We don't pick a valuation, they don't give us a range. And we pick, there's different methodologies. We pick what we think is the best institutional practice. And that valuation process ultimately goes to our board. Board has independent, uh, board members that sign off on the valuation. Um, but I just wanna get to the guts of your question. 'cause honestly, I think there's a lot of confusion here. We invest in loans. They have a contractual interest rate and a contractual obligation to repay us at par in almost every one of the loans that we make. We expect to get par unless there's a credit problem. So any loan that we make, we typically are making loans around 98, 99 cents on the dollar. When you factor in fees eventually, and the loans mature in five to seven years, eventually we should get back par in that five to seven years. And for a good performer, that loan should be marked depending upon where spreads are, as long as there's not a credit problem. In the high nineties, if you look at our book, you would see the average loan is marked right between right where I'm saying 98, 99. If you looked at all the large managers in the space, you'll see the same. If you look at the public loan market, you will see the same, almost the entire industry is marked in the high nineties. Why? Credit quality continues to be very good. The issues that you're getting at, where there's discrepancy in the mark tends to be when there's a credit problem. When there's a credit problem, and there's a question whether that loan's again, eventually gonna get repaid at par, we will make an adjustment to that valuation. We're marking it down because of that risk beyond just general spread. And so where you see the typical, if there's a discrepancy, it's gonna be a name that's going through some credit evolution where different managers might have a different take on where that ultimately winds up. We mark once a quarter, there can be a lag. A manager might make a judgment in the second quarter. Um, other managers might have made a different judgment, but they tend to catch up. Um, you don't see significant discrepancies on names for extended periods of time. And so yes, you can go hunting around and find three names where there's a range, but in the context of an industry that's measured in a trillion dollars, they're actually fairly modest discrepancies.

Sonali Basak:

But, but with that said, you, you can understand where the confusion lies, right? Because you know, and, and it's reasonable in a public market, there are many bid, you know, there are many bidders, there are many people who are buying. There's, there's a more robust market that's got transparency through exchanges and all sorts of things. This is a private market so there you could expect a bigger spread. Is that fair for some of these, uh, contested situations?

Craig Packer:

I totally understand why. If someone's reading a story that says there was a loan at par 

Sonali:

mm-hmm <affirmative>. 

Craig:

That got marked at zero, that's alarming. What I'm saying is it almost never happens if you find one incident. I think what investors are asking is, should I expect this to happen regularly? Should I have a fundamental concern about marks in the industry? And I'm saying we've certainly not experienced anything anywhere remotely close to that. I don't think most managers have. I think this was a one off. I think generally the industry does a good job of marketing their book. And I will tell you, having spent the bulk of my career in the public markets, there are investors that will look at that market and say, actually, in times of stress, those markets can be inefficient. The public loan market, the public high yield market liquidity dries up very quickly. And so what you'll see in those markets, if you talk to folks in those markets, they'll recognize this trend, is that in those periods of stress, very small trades can drive very significant moves in value. They're actually very illiquid markets. investors should feel a general sense of confidence that marks are being done in a thoughtful and proper way. Um, and, you know, if, if they don't have that concern of their manager, they should ask the questions. Um, our process is very robust and I think it delivers very consistent, thoughtful marks.

Sonali Basak:

But, you know, uh, even if you believe that your process is robust, I think people are still looking around and saying, with these sticky situations, why is there a difference? If there's a trust in the valuation process, why is there such, why is there a spread? 

Craig Packer:

Sure. I, I, um, I hope you can take this in the right way. Um, many, many of your, uh, uh, viewers will own homes, right? You own a home <laugh>, your neighbor might own a home. Your neighbor's home might sell at a modestly different price than yours. And you might say, my home's not worth that. My home's worth a bit more, bit less. These are liquid assets. Um, generally speaking, if there's discrepancy in marks for most names, that's measured in half a point a point. If there's a more meaningful, and you'll find a handful of examples, it's five points. It's 10 points. It tends to be, as I said earlier, um, an isolated company that's going through a credit transition in a short period of time where there's just a judgment. how bad is the problem? If the problem persists, what's it going to mean to recoveries? So I think they're very isolated and they're understandable. When you go to the specific credit, these are judgements. Ultimately, as a lender, as I said earlier, if you're gonna get your money back, the loan should be more close to par. The big discrepancies come with a credit where there's a real question, are we gonna get our money back? And it's, there's a loan that's starting to trade, not quite like an equity, but it starts to look like an equity. Private equities, right? That you want to talk about valuation discrepancy, let's talk about private equity. And I don't just mean sponsor back private equity, venture capital equity, those are the asset classes where you would see significant discrepancy in how different firms might mark these assets. It's a fairly tight band in private credit.

Sonali Basak:

So it's interesting. And you're speaking to, to dispersion as well. I think the reason I'm asking, I'm glad you got to private equity, <laugh> private equity, uh, has been a very controversial space in the last couple of years because there have not been enough exits. They've taken on much more debt to be able to keep a lot of these companies, uh, floating along these, this debt has come at a higher interest rate of late, right? So, so what happens, right? You have a lot of private equity backed firms. I understand your point. You're saying that if there is an issue in the portfolio companies, the private equity firm is the one that loses the money actually because they're the equity holder. SO then what happens to the credit?

Craig:

Um, if there’s, if there’s a default?

Sonali:

Yeah, because, you know, we're getting to this point now, where you've seen the private equity industry extend and amend. 

Craig Packer:

Well, I, I would, I would maybe break, break this into a couple pieces. Private equity has delivered fantastic returns to investors for many years. Um, that's why it's such a popular asset class. You're absolutely right. We're in a period of time the last few years where, um, there haven't been enough exits to return capital to LPs at the pace the LPs would like and the pace that the GPs would like. Um, fundamentally, I think that speaks to generally, you know, prices were that were paid three or four years ago when rates were lower. Um, economy's done, done fine, but maybe hasn't grown as robustly. So you have private equity firms sitting on good companies, but they haven't generated the return that they would like before they exit. And they're finding ways to hold the companies longer. One of the ways they're able to return capital in the meantime, as you're saying, is, is they're doing recaps, businesses perform well. It's the levered, I'm gonna lever back up to the original return some capital to LPs good business. I'm gonna hold it longer. Um, I think ultimately that speaks to the returns for the LPs. Not that there's problems in the companies. so I think private equity is going to continue to deliver. Now there's a whole other set of, of problems, and there aren't very many of them candidly, which is, well, okay, what if it's not just time? There's a problem with the company. As a direct lender, we invest considerable resources at being able to work through problems. We have a workout business. Um, we have had very few workouts in the history of our firm. Our companies perform well and mentioned earlier at a 40% loan to value. The private equity firms very motivated to continue to put money into the business to support it. That's what we saw during COVID. That's what we've seen for the most companies, even ones that have have performed poorly. The private equity firm works with us to keep the company every so often. And our loss rate at a firm is measured as 13, 15 basis points. But every so often, the circumstances of the business have fundamentally changed. Where the private equity firm, not only, um, has essentially lost their equity investment, but they don't see a prospect to get it back. In those cases, typically we will work with them to come up with a plan, uh, to consensually, essentially hand us the keys. That typically takes, it could take six months, nine months, a year in the making. This isn't something that crops up overnight. We have great visibility on the companies. We have lots of conversations, but if, if they, if they feel it's the best decision they can make, and we've tried all other alternatives, we're in a position to take over the business. Sometimes I think people conflate, um, a workout or a bankruptcy with we get a zero. That's not how it works. I mentioned earlier we're in a 40% loan to value. That means the business can lose 60% of its value. And if we…

Sonali Basak:

You cover business can make money, actually,

Craig Packer:

Look, we're not trying to make money on those problems, but we are very much trying to get a very high recovery. If we can get back 70, 80, 90 cents on the dollar on our problem loans, um, we're gonna have a great return. And I want you to understand, and I say this all the time, we don't have to be perfect when we underwrite, we underwrite each deal to get repaid, but in aggregate, we assume some losses in the portfolio as a result of these problems. The point is, we're earning a high return on everything else that it offsets the losses, industry loss rates annualized or about 40 to 50 basis points. We've been running at about 15. Okay? So it's well under, I tell clients, don't assume, we'll assume we'll be modestly higher. We factor it into the returns. And you should. So you should care a lot in investing in a fund that has very low defaults and has a good job of getting recoveries and these loss rates. We all publish them. You should pay attention to them. Um, but you shouldn't be spooked by one or two headlines and say, well, this is a problem. It's part of the industry. And we work really hard to get high recoveries on those problems.

Sonali Basak:

Yeah. Speaking of kind of potential future losses, just to kind of prepare the public for this, because realistically speaking, between now and the end of 2026, there will be losses in the industry. Um, I think the one question back to the cockroach conversation, right? The Jamie di, I know Al didn't quite agree with him. I understand why there was a lot of bank losses rather than private credit losses. But to the extent that there would be more cockroaches, you know, how do you look around the corner to understand where those cockroaches will come from? Yeah,

Craig Packer:

So, you know, it's, it's interesting. I'm not gonna change topics on you, but, if I was here 18 months ago, we'd be having a conversation about rates and everyone would be asking me, rates are high. How are your companies gonna survive these higher rates? What's your interest coverage ratio? You know, how many of your companies are below one times coverage, below two times coverage? No questions anymore. Right? Rates were high. The companies managed through it.  I think now the question is more about just general economic conditions. You know, if the economy slows, how are the companies gonna do Fair questions? I expect our companies to continue to do well. We continue to see that. as I said earlier, we have a watch list. The industry, generally good managers have a watch list. That watch list tends to be five to 10% of the portfolio. I'd say more like 5% of the names you're really worried about. Um, that doesn't mean those 5% are gonna have problems that become defaults, but that's the, it's a very small subset of the names you worry about. And I expect the portfolios to continue to do well.

Sonali Basak:

What are the problems in the watch list?

Craig Packer:

What, what are those

Sonali Basak:

Types of problem? Yeah. What are are the types of problems?

Craig Packer :

Yeah. You know, they tend to be very idiosyncratic. Um, something's happening with, with a customer demand issue. Um, we certainly see if you said, well, where are there a little more problems? Some of the businesses that touch the consumer 

Sonali:

mm-hmm <affirmative>. 

Craig:

Um, tend to have a little bit of some of situational weakness. Not programmatically, but occasional cases. Um, if we have a business that's serving a discretionary consumer need, if consumers are tightening a bit, we have a couple businesses that were impacted by tariffs. When I say a couple, I mean a couple, but there are a couple businesses that maybe weren't doing so well pre tariffs. And then the tariffs have, impacted their cost structure. But there's no broad theme. And I'll tell you one area, and we can talk about this if you like, our software business can do, do very well. And it's a very common question we get now in the age of AI, our software portfolio is, is probably our single best portfolio. Those companies continue, continue to be very strong.

Sonali Basak:

I'm totally dragging you back in here to talk about software next year. 'cause as AI gets into the space, it's a lot of questions. But I do need to push on the cockroach question because of this. You know, it's interesting. Howard Marks made this really interesting point. I, um, I, I dunno if you read his letter where he makes a point that maybe it's not systemic, but maybe there's something systematic that had happened here that in the last, you know, decade or so, rates were low, everyone looked like a genius underwriting, right? You know, perhaps there was some, uh, lack of rigor in underwriting that led to some managers being exposed to fraudulent names. Would you agree with that?

Craig Packer:

I think that if you bring something to the highest level, you know, it's hard to disagree with these concepts.  we dedicate an incredible amount of resources to picking the names that we lend to. Um, we work on them for months. We get a lot of information. We structure our deals very carefully. Um, and I'd say our large peers do as well. I don't think that you're gonna see a lot of systematic fraud.  I appreciate we're gonna keep getting asked about it for a period of time. Uh, but I don't think you're gonna see a lot of fraud. Um, I think it's notable that the couple of fraud instances were not backed by private equity firms. I think that that's a, an underappreciated aspect of this. I think the industry, generally, the large managers lending, the large companies backed by large private equity firms have been thorough, careful, and they're not gonna be surprised by a rash of credit problems. Certainly the asset class has grown. Um, there are lower quality managers, there are managers that invested in tougher, riskier parts of the, of the private credit market. And you might have isolated incidents, just like any asset class, even in the public markets. There are managers that just don't do as good a job. But I think that there's a difference between saying the economy may slow, may have some more problems. I agree with that and saying, I think what investors are worried about is, is this built on a solid foundation? Is the underwriting good? Is the marks good? is the liquidity good? And I would say it is. And I think you'll continue to see good results. That doesn't mean in a quarter you can't have a name or two that has a credit specific problem. Any good manager doing lending of any type for any extended period of time will have credit problems, but it won't affect the overall risk adjusted return in the industry.

Sonali Basak:

Lastly, before I let you go on, returns worth the question because you're getting into what has been, uh, a cycle in which you're finally seeing rates come down. Base rates come down. These rates are, uh, are often floating rate loans. And so there's a lot of question about what the return profile looks like in a lower interest rate, relatively lower interest rate environment. At a time when credit has been so plentiful, the leverage loan markets had been open throughout the course of the latter course of 2025. What do you think this means for returns moving forward? 

Craig Packer (00:39:25 -> 00:40:53)

Yeah, we, you said it. We invest in floating rate assets. Investors need to understand that almost every loan we make is floating rate. Um, the positive of that is you don't need to make a bet on rates. If you invest in bonds, you're making a bet on rates. Fundamentally, in the loan asset class, it floats. Rates go up, we earn more. Rates go down, we earn less For a number of years. Rates were very low. Um, our products were very popular in that environment because in a very low rate environment, investors were really wanted that higher return rates went up, our dividends went up, we paid out all that capital, earn more. Um, but now rates are coming down and we're earned a bit less. It's going to float. Um, I would say generally the funds are designed to generate anywhere from a high single digit to a low double-digit rate of return depending upon rates. Um, for the last couple years it's been in that low double-digit rate, envir, uh, return. If you think rates are gonna come down, you should expect it to migrate to that high single digit. But it's all relative, right? Last year you might not have been happy with a high signal digit rate of return. If you think that, so FR is going to 3%, which is where the market thinks, then if you're gonna earn an eight or nine, that's gonna seem very good. Um, so I think that it, it's all relative to what your alternatives are. The high yield bond, the leverage loan market today, they're yielding six, 6.5%. We're offering a significant premium. We're designed to offer a premium regardless of the rate environment. As long as you have good credit performance, it keeps coming. You've asked about that. It keeps coming back to that.

Sonali Basak:

I gotta let you go. But you know, it's interesting. I think about 2026 and you can't, you have, you wonder if you're gonna see double digit percentage points returns in equities. Has anyone ever said to you, well, you know what? One case for private credits, actually equities might not be performing too far behind private credit with greater risk.

Craig Packer:

I think that, you know, I appreciate, uh, your ending on a, on a really positive note. I think that really explains why these products are so popular. Investors, I think understand it maybe more than we give them credit for. They're investing in an asset class that's gonna generate a very consistent dividend rate that in many cases can approach equity-like returns without the same volatility and without the same downside. 

Sonali Basak:

Yeah. Wild, uh, market that's changing very quickly. Craig, thank you so much for taking our questions. It's a big topic. We hope to have you back on soon. That is Craig Packer. He is the co-president and head of credit at Blue Owl.

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