Private Credit Isn’t Safer than Banks — It’s Just Better at Hiding Losses

Why It Matters

Inflated performance numbers mask hidden losses, exposing retail investors to unexpected downside and eroding confidence in an expanding alternative‑credit sector.

Key Takeaways

• Private‑credit funds can mark up discounted loans to NAV instantly.
• Redemption caps force funds to sell assets at discounts during redemptions.
• SEC fined adviser for misrepresenting fair‑value in affiliated fund deal.
• Regulators urged to clarify ASC 820 and require independent loan appraisals.

Pulse Analysis

The private‑credit market has exploded over the past decade, offering companies outside the traditional banking system a source of capital while promising retail investors yields that outpace stocks and bonds. Because these funds are illiquid, investors can only redeem quarterly and are subject to a 5 % cap on total withdrawals. When redemption pressure spikes—as it did this quarter with requests exceeding 20 % of NAV at two Blue Owl funds—managers must generate cash quickly, often by selling loan portfolios at steep discounts. The accounting rule ASC 820, which defines fair value as an "exit price" in an orderly transaction, permits buyers to treat the loan’s book value as a practical expedient, enabling an immediate mark‑up that boosts reported performance without any real economic gain.

The practice becomes especially opaque when the buyer is an affiliated continuation fund. In such cases, the original fund sells loans at, for example, 85 cents on the dollar, and the continuation fund records them at 100 cents, creating a phantom return that misleads investors about skill versus accounting sleight‑of‑hand. The SEC’s recent enforcement action against an adviser that certified a fair‑value purchase despite a material price disparity underscores the regulatory blind spot. The adviser violated fiduciary duties and antifraud provisions, illustrating how current guidance allows manipulation of NAV figures while leaving investors in the dark.

For the broader market, these accounting tricks pose a two‑fold risk: they can erode investor trust in alternative‑credit products and, if widespread, may amplify losses when the underlying loans mature or default. Policymakers are therefore urged to tighten ASC 820 guidance, prohibit the use of a loan’s stated book value as a practical expedient when a contemporaneous transaction exists at a different price, and require independent, qualified appraisals for affiliated deals. Greater transparency would align reported performance with actual cash flows, safeguarding retail participants and preserving the credibility of the private‑credit ecosystem.