PIMCO: What BDC markets are signaling about private credit valuations
BDC equities continue to trade at significant discounts to NAV, reflecting skepticism toward reported marks, a concern reinforced by valuation levels that have yet to fully reset, even as BDC bonds continue to outperform their stocks.
By Lotfi Karoui, Multi-Asset Credit Strategist, PIMCO
The performance across the capital structure of BDCs – funds that invest in small and midsize private U.S. businesses – continues to diverge, with their bonds outperforming and equities lagging. What explains this gap?
The simplest answer is an asset valuation story. Credit investors have recourse to the assets against which they lend, while equity investors are increasingly focused on the credibility of reported net asset values (NAVs). Equity investors are essentially demanding more risk premium as compensation for the uncertainty around the true marks of portfolio holdings, and this skepticism is unlikely to abate without a better price discovery mechanism.
Indeed, in our view, the true valuation reset has yet to begin in earnest. More than two quarters after redemption pressures began to weigh on semi-liquid direct lending vehicles, and despite a growing number of signs of financial distress across parts of the market, BDC portfolios show little evidence of a meaningful valuation reset. Loan marks remain elevated, both in absolute terms and relative to the broadly syndicated loan (BSL) market.
If anything, the gap appears to be widening. While similar divergences emerged during periods of acute stress, such as the COVID-19 shock or the 2022 Russia-Ukraine war and subsequent hiking cycle, the current episode is unfolding against a backdrop of relatively more benign market conditions and low levels of systemic stress.
The challenge for BDCs extends beyond elevated marks on existing loans. The incremental yield advantage available in new direct lending transactions has also compressed substantially. Deals originated in 2017 and 2018 offered BDCs an average spread pickup of more than 300 basis points (bps) over leveraged loans. By the first quarter of 2026, the most recent period for which filings are available, that advantage had fallen to less than 100 bps.
In other words, while existing portfolios continue to be carried at elevated valuations, the economics of deploying new capital have become increasingly less differentiated from those available in public credit markets.
Where might this divergence between public market pricing and BDC marks lead? The recent experience of private real estate offers a useful, albeit imperfect, precedent. During the 2022 dislocation, private real estate vehicles initially resisted the decline seen in publicly traded REITs, only for valuations to converge later through a combination of public market recovery and private market markdowns.
A similar outcome cannot be ruled out for BDCs. That said, the adjustment process is likely to be slower, given the support provided by bank credit facilities, ongoing principal repayments, and the presence of liquid assets that can be sold to meet cash needs. Nevertheless, if marks ultimately need to move closer to where comparable risk trades in public markets, the potential for further valuation pressure on BDC equity remains a meaningful risk.