Fund Seen As "First Domino In Private Credit Bank Run" Hit With Over 7% In Redemptions

Less than a month ago, when the latest, SaaS-driven meltdown in Private Credit was just starting, Rubric Capital, a hedge fund founded by a former Point72 manager David Rosen, wrote a private letter (available here to pro subs) to their LPs saying private credit is a fraudulent bubble. 

"Our key takeaway from this behavior is that distribution cuts are so worrisome that some bad actors are playing Enron-like accounting games" the letter claimed, noting that similar to Lehman's Repo 105, the firms are using repo-like loans from one particular investment bank to mask debt. It also warned that as a result of extremely easy underwriting standards, BDC leverage had increased to 8.5x of EBITDA, while 43% of private credit borrowers have negative free cash flow, a striking statistic.

The letter's stark conclusion was that after a solid run, the ending is coming and it would be anything but happy: "We think a “run on the bank” is inevitable and would recommend all investors to get out of levered private credit while they still can. This is the story of a $2.0+ trillion market on the precipice."

While in his letter Rosen focused primarily on the bubble's usual suspects such as Blue Owl and Ares, the Rubric founder also called out Cliffwater, the biggest operator of interval funds and an aggressive player in selling private credit to individual investors. This is what he wrote: 

The industry realized that the fleeting liquidity offered by BDCs would not sell well to retail investors that may legitimately need nearer term liquidity, so they began aggressively pitching semi-liquid solutions in the form of interval funds. Interval funds, like BDCs, offer quarterly liquidity, but with a key difference: they are required to repurchase at least 5% of outstanding shares and are not permitted to impose gates. These interval funds have now grown to more than $80bn in net assets, with roughly half coming from Cliffwater – a private credit research firm turned interval fund manager that, from what we understand, is already facing capital constraints. 

As Negligible Capital pointed out last week, Cliffwater’s largest fund, started in June 2019, has since reported just three negative months of investment performance, a Madoff-esque accomplishment, which helped lift its asset under management to $33 billion.

More problematic for Cliffwater, which as a reminder can not gate investors - unlike Blackrock - the first opportunity this year for investors to ask for their money back would be... this week, which would reveal if indeed the fund was facing "capital constraints."

Incidentally, Rosen's letter went on to say that he "would not be surprised if Cliffwater is the canary in the coal mine and will be the first domino in the “bank run” we foresee."

So fast forward to today, when inbetween the barrage of Iran-related headlines, Bloomberg reported that Cliffwater has indeed hit the brick wall of "capital constraints", after it was flooded with a barrage of redemption requests in excess of 7% from its flagship private credit fund. 

As noted above, the $33 billion Cliffwater Corporate Lending Fund is structured as an interval fund, requiring it to repurchase up to 5% of its shares each quarter if investor requests meet that threshold. If redemptions exceed 5%, Cliffwater has discretion to repurchase as much as 7% of outstanding shares.

Founded by Stephen Nesbitt - who prides himself in having "launched one of the first evergreen private debt funds directed at the retail channel using multiple lenders to source loans from middle market companies and placing Cliffwater at the very center of efforts to “democratize” alternative investments" - Cliffwater is the latest firm in the $1.8 trillion private credit market to face an investor exodus over concerns about loan quality and exposure to software companies that could be disrupted by advancements in artificial intelligence.

The fund’s tender window is set to close Tuesday, and the firm hasn’t yet decided whether to limit redemptions at the 5% or 7% mark, reproted Bloomberg. 

As we reported last week, BlackRock was the first major player in the private credit space which gated investor withdrawals from its HPS Corporate Lending Fund at 5% after investors sought to cash in nearly double that amount, marking the first major instance of a private credit manager limiting redemptions on a perpetual vehicle since the recent market turmoil began.

In contrast, just days earlier Blackstone allowed investors to redeem a record 7.9% of shares from its flagship fund, known as BCRED, after tapping roughly $150 million from senior leaders who contributed their own capital, along with about $250 million from the firm itself to offset the outflows.

In November the Cliffwater fund was given a credit grade of A by S&P Global Ratings, which cited its high diversification and relatively low leverage compared with most private debt vehicles. The report also noted its strong asset quality and cash flow, confirming yet again that just like during the 2008 crisis, rating agencies will emerge as some of the biggest enablers of this cycle's credit bubble. 

Like its troubled peers, Cliffwater has pushed back against concerns over the quality of the market’s underlying assets, arguing that sentiment is driving the selloff in private credit funds more so than fundamentals.

Perhaps, although we would counter that if anyone still harbors such naive views after reading the must-read letter from Rubric Capital, they certainly deserve to be gated into oblivion.

Much more in the full Rubric Capital letter available here to pro subs.