Bank of America is peddling a fantasy that you can short the backbone of European mid-market finance and walk away with a clean profit. They want you to believe that the "Golden Age" of private credit is over, that interest rates have finally broken the camel's back, and that a wave of defaults is about to wash away the direct lending market. It’s a neat, linear narrative. It’s also spectacularly lazy.
The smart money isn't betting on a collapse. It's betting on the fact that the public markets—the very ones BofA represents—cannot handle the complexity of what’s actually happening on the ground in Frankfurt, Paris, and Milan.
The Myth of the Floating Rate Death Spiral
The core of the "short private credit" thesis relies on a single, shaky pillar: rising interest rates. The logic goes that because private credit is almost exclusively floating-rate, the sheer cost of debt service will suffocate borrowers.
This ignores the reality of how these deals are structured. I’ve sat in the rooms where these covenants are drawn up. Private credit isn't a faceless bond market where you hit a button and sell when things get shaky. It is a relationship business. When a borrower hits a wall, the lender doesn't immediately trigger a liquidation. They swap equity, they PIK (Payment-in-Kind) the interest, or they inject fresh capital.
In the public markets, a default is a messy, public funeral. In private credit, a default is often just a quiet "amend and extend" session over coffee. BofA’s pitch assumes the market is rigid. It isn't. It’s liquid oxygen—it fills whatever shape the container takes.
Why the "Zombie Company" Narrative is a Distraction
Critics love to talk about "zombie companies"—firms that only exist to pay off the interest on their debt. They argue that private credit is keeping these corpses upright.
Let’s look at the math. In a typical European direct lending deal, the leverage might be $5x$ or $6x$ EBITDA. If rates jump from 2% to 5%, the interest coverage ratio (ICR) drops.
$$ICR = \frac{EBITDA}{\text{Interest Expense}}$$
If your $ICR$ drops below 1.0, you're in trouble, right? In the public markets, yes. In private credit, the lenders are often the same people who own the equity or have a direct line to the Sponsors (Private Equity firms). These Sponsors are sitting on record "dry powder"—trillions of dollars in uncalled capital. They aren't going to let their prize assets go to zero because of a temporary rate spike. They will bridge the gap.
BofA is betting against the resilience of the most capitalized players in human history. That is a losing trade.
The Liquidity Trap BofA Isn't Telling You About
The most dangerous part of the "short European private credit" pitch is the execution. How exactly do you short a private, illiquid loan? You don't. You short the proxies. You short the listed business development companies (BDCs) or the European collateralized loan obligations (CLOs).
This is where the strategy falls apart. The "proxy" is not the "asset."
I have seen traders lose their shirts trying to use liquid instruments to hedge illiquid risks. When you short a European CLO index to bet against private credit, you aren't betting against the quality of the loans. You are betting on market sentiment and technical liquidity. If the market stays irrational longer than you stay solvent, the "basis trade" will incinerate your capital.
The Real Risk is Not Default, It’s Stagnation
If you want to attack private credit, stop talking about defaults. Start talking about the "LBO Clog."
The real problem in Europe isn't that companies are going bankrupt; it’s that nothing is moving. Private Equity firms can't sell their companies because the valuation gap is too wide. Lenders can't get their principal back because there’s no exit.
This creates a "Hotel California" market: you can check in, but you can never leave. The returns won't be -20% (the crash BofA is hinting at); they will be a boring, flat 4% for seven years. For an asset class that promised double digits, that is the real failure. But you can't "short" boredom.
The "Shadow Banking" Boogeyman
Regulators and big banks love to use the term "shadow banking" to make private credit sound like a dark alleyway deal. It’s a branding exercise designed to claw back market share.
The truth? Private credit is often more transparent to its stakeholders than public credit. A direct lender has access to the borrower's books every single month. They see the cash flow in real-time. A bondholder in a public BofA-led deal sees a quarterly report and prays the management isn't lying.
By betting against private credit, you are betting that "regulated" banking is more efficient. After the collapses of 2023, does anyone actually believe that?
Stop Looking at Interest Rates, Start Looking at Spreads
The "lazy consensus" says: Rates up = Credit down.
The "insider reality" says: Credit spreads tell the real story.
In Europe, even as the ECB hiked, the spreads on high-quality private debt remained remarkably stable. Why? Because there is too much money chasing too few deals. This "wall of capital" acts as a floor for valuations. Even if a company's fundamentals soften, the sheer volume of capital waiting to be deployed prevents a price collapse.
The Strategy for the Fearless
If you actually want to make money in this "crisis," you don't short the market. You buy the "messy" middle.
- Avoid the Mega-Cap Deals: This is where BofA hangs out. It’s crowded, overpriced, and prone to the same shocks as the public markets.
- Target the German Mittelstand: These are the family-owned, mid-sized industrial powerhouses. They are terrified of banks and loyal to their private lenders. The default rates here are historically lower than anything BofA has on its books.
- Embrace the PIK: Look for managers who are comfortable taking interest in additional debt rather than cash. It shows they trust the long-term value of the asset over short-term liquidity.
Everyone is looking for the "Big Short" in European debt. They want the dramatic 2008 moment where everything goes to zero. It’s not coming. The European market is too fragmented, too relationship-driven, and too over-capitalized for a clean systemic break.
BofA is giving you a map of the world from 1995. They are treating private credit like it’s a volatile tech stock. It’s not. It’s a slow-moving, deeply entrenched, and highly guarded fortress of capital.
Betting against it isn't "smart hedging." It's a fundamental misunderstanding of who owns the keys to the European economy. While the analysts at BofA are busy writing reports about the coming storm, the private lenders are simply buying the umbrellas and charging the borrowers for the privilege of standing under them.
Don't short the lender. Become the lender.
