Subprime to Private Credit: A Fund Shift

If there is a generator of financial bubbles, it is credit. In fact, Credit bubbles are often the drivers of volatility in the economic cycle.

In the beginning, credit is used wisely. Banks, scalded by previous crises, monitor who they give credit to. But little by little, Credit requirements or standards are relaxing. Defaults begin, the crisis comes and credit is restricted again.

This has happened all my life, but, as the story progresses financial engineeringit happens like with fires: credit crises become third generation crises. We had the most obvious example in the “subprime” mortgage crisis, which led to the Great financial crisis of 2008. And I’m afraid we’re going to have it where we’ll call Private Credit Crisis. It probably won’t be as virulent nor will it be soon, but it will be a crisis nonetheless.

For practical purposes and so that everyone understands it, we will say that private credit is that which is generated outside the traditional banking circuit. It is also called “shadow banking“(shadow banking). It is a sector in which there are different players, but we are going to focus on the version private credit funds or “private credit”, also closely related to “private equity” or private equity funds.

The problem is not that there are funds that are dedicated to this activity, but that their activity is much less controlled and monitored than the credit given directly by banks. As he warns UBS CEO, Colm Kelleherthe rating of the operations of private credit funds is done fundamentally with small rating companiesamong which there is fierce competition and are increasingly aggressive when it comes to attracting customers. And in that business, being aggressive means less demanding.

Yes to BCE It is difficult for him to control the relatively small number of banks in Europe – and that is why he wants them to be few and large – imagine how difficult it is control hundreds of investment funds dedicated to private credit. Which are also not controlled by a central bank, but by the fund market supervisorwhich normally does not have the means that the latter has.

Until now it has not been a problem, because they were products that They could only be sold to qualified investorswho are supposed to understand very well where the fund is investing. The managers knew this and acted accordingly.

Now, when the season is open for all types of investors to invest in private equity and credit fundsneither investors understand the product, nor do they know what to ask, nor do they know where to look, nor do they have the necessary weight to ask for data and demand answers. In addition to the ban, has been opened pandora’s box.

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The other factor that prevented problems was volume: by targeting only specialized investors, it was not massive volume in the hands of hundreds of thousands of investors. Now yes. The commission revolution has caused them to decrease fund management fees traditional companies and financial entities have found in private equity and credit funds the formula to increase these commissions. A little lobby and they can now be sold to everyone.

As if this were not enough, it coincides with a moment in which Demand for credit skyrockets due to the arrival of AIwhich requires enormous investments. And before going public, companies like OpenAI or Anthropic are financed with private capital and credit. They are many, very large and will be very profitable in the future, but there could be delays in the fulfillment of business plans or even non-compliance. To give us an idea, yes Nvidia It seems to everyone like a “bubble” with a PER of 32 (with an estimated 12-month profit), I wonder what they would think if they knew that the dozen unlisted companies to which I refer usually have PERs greater than 100 and 200. And be careful: they are owned by large companies on the NASDAQ and also receive loans from large banks, so if something were to happen there would be a contagion effect.

So we have the critical mass and the components for the creation of a credit bubblein a context of economic prosperity in which credit standards tend to relax. And Mrs. María and Mr. Juan Inversor with 15% of their portfolio in these products, thanks to the new regulation. What a cocktail.

I’m not trying to be a catastrophist, you know it’s not my style to sell fear. And I don’t see it being a problem in the short term. But we must be careful, especially given the similarity with that “bundling” of “subprime” mortgages together with healthy mortgages to place the “package” in the form of structured product to investors. In the future, the “package” could end up being a credit investment fund or of private equity. And, as the Boomers know well, a “package” was called a footballer who cost a lot of money and neither ran nor scored goals.

If there is a generator of financial bubbles, it is credit. In fact, Credit bubbles are often the drivers of volatility in the economic cycle.