Bank of America Securities is advising clients on a strategy to short stocks with exposure to European private credit, with institutions like Deutsche Bank AG and Partners Group featured prominently. This move follows Goldman Sachs, which recently began marketing derivative instruments to hedge funds for shorting corporate loans. The consecutive actions by these two Wall Street giants in establishing short positions in the private credit market have sharply heightened systemic risk concerns for this asset class.

According to a Thursday report by the Financial Times, Bank of America warned clients that European stocks with private credit exposure face a 30% "downside risk" compared to their U.S. counterparts, as their declines have not yet matched those seen stateside. The bank specifically constructed a basket of 17 European financial stocks for shorting, which includes insurers Axa, Legal & General, Aviva, and pension group Aegon, in addition to Deutsche Bank AG and Partners Group.

This development comes as pressure builds in the private credit market. Following Blue Owl's announcement of permanently gating redemptions for one of its funds, the sector experienced heavy selling—Blue Owl's market value has dropped approximately 40% year-to-date, while Blackstone has declined 27%. Wall Street's role in providing shorting tools during periods of accumulating risk has drawn comparisons to the pre-2008 financial crisis environment for some market observers.

The core logic behind Bank of America's short recommendation is that the valuation adjustment for European private credit-related stocks is not yet complete. The bank argues that, compared to the significant corrections already experienced by similar U.S. assets, European stocks have lagged in their decline, creating a potential 30% downside.

The custom short basket created by Bank of America for its clients includes 17 European financial stocks spanning various subsectors like banking, insurance, and asset management. Deutsche Bank AG and Partners Group are listed as representative targets "most exposed to private credit shocks," with insurers Axa, Legal & General, Aviva, and pension group Aegon also included.

Notably, Bank of America itself is not shying away from the private credit market. Just last month, the bank announced it would deploy $25 billion into private credit lending, even as concerns about credit quality and liquidity were already mounting.

Meanwhile, analysts within Bank of America's research division expressed a view on Wednesday that media focus on private credit "remains excessive" and centers on "low-value data points," which they believe is driving the current sell-off. They characterized the situation as a "fire-sale buying opportunity." This internal divergence at Bank of America highlights the highly fragmented market judgment regarding this asset class.

Bank of America's move is not an isolated case. As previously reported, Goldman Sachs has already taken the lead in promoting a shorting strategy for corporate loans to hedge fund clients, utilizing a derivative instrument known as a "total return swap," which allows investors to profit when loan prices fall.

According to informed sources, Goldman Sachs recently received inquiries from several clients and has proactively contacted hedge funds interested in shorting loans to technology companies. However, no actual transactions have been completed thus far. The core logic for hedge funds seeking short positions lies in the dual exposure to private credit and the software sector—Blue Owl is at the center of the current turmoil due to its substantial lending to software companies. Concerns about the viability of software companies, triggered by advancements in AI technology, directly led to the gating of its fund.

The fact that two top Wall Street institutions have successively established shorting channels for clients indicates rapidly rising demand from institutional investors to hedge risks associated with private credit assets. The market is seeking more structured tools to express this view.

Signals of stress in the private credit market are intensifying. Beyond Blue Owl's gating of redemptions, Blackstone's private credit fund faced a record 7.9% in redemption requests, BlackRock announced restrictions on redemptions for its $26 billion corporate loan fund, and PIMCO warned of a "full default cycle" approaching for the direct lending industry.

In response to external skepticism, European bank executives collectively spoke out this week in an attempt to stabilize market expectations. Deutsche Bank AG CEO Christian Sewing stated on Tuesday that the bank has not lost "a single cent" in over a decade of private credit business. Following last week's disclosure of a €26 billion private credit exposure, he emphasized, "I don't see this as a particular risk for us," adding that Deutsche Bank AG is a "very sound underwriter" in this business area.

Partners Group Chairman Steffen Meister acknowledged to the Financial Times last week that private credit default rates could double in the coming years but stressed that institutions employing strict "private equity-style" underwriting standards can still achieve strong credit returns.

The current situation feels familiar to some market observers. In the lead-up to the 2008 financial crisis, a team led by Deutsche Bank AG trader Greg Lippmann marketed $35 billion in credit default swaps (CDS), helping clients short subprime mortgages, which ultimately generated substantial profits for the bank during the crisis. Wall Street's role as a provider of shorting tools during periods of risk accumulation appears to be replaying now in the corporate loan market.

This comparison is not without controversy. The scale and structure of the current private credit market are fundamentally different from the 2008 subprime market, and European bank executives are emphasizing the robustness of their portfolios. However, the mere fact that Goldman Sachs and Bank of America have successively entered the market to build shorting tools for clients is enough to prompt investors to re-evaluate the risk pricing of private credit assets—especially in Europe, where the valuation adjustment for related stocks may have only just begun.