Institutions Want Out… But Private Credit Won’t Let Them Leave

Private credit really has a problem on its hands, and this is getting to be different. For months, the story has been retail investors trying to yank their money out of the space. You know, wealth management clients are getting nervous and non-traded BDCs are being pushed up to the redemption limits. Investors trying to remove cash from funds that were never really designed to be cash on demand. But this is getting to be different. Now we have another story which confirms a single large investor pushed another private credit fund way over the limit of its redemptions. And this one, a Swiss investor, a Swiss pension fund. This thing really is getting to be institutional. That matters because this was not a stampede of so-called mom-and-pop investors. It was not panic selling for thousands of retail accounts. It was a single institutional investor, a pension fund, a Swiss pension fund asking for its money back. Because if the first phase of stress was retail investors realizing private credit was not as liquid as advertised or what they thought was being advertised, this next phase is institutions looking at the same market and coming to the same decision, if for somewhat different reasons. They want out too. At the same time, another major development is happening. Financial firms are increasingly shying away from loans to software companies, to the point some asset managers are now openly marketing debt securities with a key selling point. Less software exposure. Think about that. That's how an asset class starts moving toward toxic waste status. Not overnight, not all at once, but one avoidance strategy at a time. So what we're going to go through today is more escalation in private credit, including confirmation of a Swiss institution, a pension fund, forcing a private credit fund right to the limit with just its one single loan withdrawal request. And then we have to ask the question, is software becoming the new subprime mortgages? Now, I mean, there are very big differences there. It's not an exact parallel, but in the grand scheme of things, about how these crisis and how these bubbles turn to bust actually play out, behavioral changes, the transition and process that goes to toxic waste. Is software the new subprime mortgage? And unfortunately, we're getting some initial evidence that's increasingly the case. And it goes right along with what we just talked about, Swiss pension funds and institutions that are pulling out from the entire area. Think about how we now have a Swiss pension becoming entangled in the bust, showing once again the global nature of private credits reach and how far flung the consequences from the bust are going to be. Now, according to Bloomberg, a large redemption request from a Swiss pension fund helped force a Vista private credit fund to limit withdrawals. And that detail is critical because when people hear redemptions or withdrawals, they often imagine a wave of retail investors. In fact, they're led to imagine a wave of retail investors. Financial advisors are getting panicky calls and wealth management clients are getting nervous and a broad rush from the exit from the little guys all over the spectrum. And yes, that's been part of the story, though a much smaller one. Non-traded private credit funds have been dealing with rising withdrawal requests for months as we've been documenting and being careful to catalog. Many have redemption caps, often around 5% per quarter, and a lot of them have had to enforce the limits. But the Vista situation adds a different wrinkle. Here's the quote from Bloomberg that captures it. Quote, the withdrawal request from a single institution rather than legions of retail investors paints a very different picture than the redemption pressure that has engulfed the $1.8 trillion private credit market in recent months as concerns mounted over loans to software companies threatened by artificial intelligence. Now, that's the very narrow concerns gone to be much broader than that, but that's a good place to start. And this point is a key one. A single institution, not legions of retail investors. And this is where the narrative really starts to shift or really should have already shifted because this is just more confirmation. Private credit defenders have tried to frame the redemption issue as retail product problems. Their argument is basically, you know, private credit itself is fine, but some semi-liquid funds were sold to investors who didn't fully understand the liquidity mechanics and liquidity terms. And there's some truth to all that. But if institutions are also pulling their money out, and we see that all over the place, that explanation just doesn't hold the same amount of water. A pension fund is not supposed to be emotional tourist money. A pension fund is supposed to be long-term capital. It has consultants and due diligence processes. It understands lockups, gates, liquidity limits, and the bigger picture, the credit cycle. So when a pension fund wants out, the market should pay attention. Everyone should pay attention, especially when we're starting to see many more examples to the point where the vast majority of withdrawals are coming from institutions. I almost never do ads, and I say no to the vast majority of those that are brought to my attention, but I was thrilled to be able to work with today's video sponsor, Monetary Metals. And the reason is because they're solving a big problem, one that I've been highlighting for a very long period of time. 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What does that really matter? But that's actually the point. If one large investor is big enough to force a fund to limit withdrawals for everyone else, it tells us something about the overall structure. These vehicles are often marketed with some form of periodic liquidity. Investors can redeem shares subject to limits. But the underlying assets are private loans. They don't trade every day. They don't have deep transparent markets. And in stressed conditions, they may only be saleable at a discount, if they can be sold at all. So a fund can look liquid when money is flowing in, but when money starts flowing out, the structure gets tested. If new money is coming in, redemptions are easy. Investor A wants out. Investor B comes in. The fund uses new subscriptions to satisfy those withdrawals. But when inflows slow and redemptions rise, the fund has to find cash somewhere else. It can use its reserves, but it can also slow new lending. It can borrow, but that's becoming increasingly difficult. Usually, it has to sell assets as well as limit those redemptions. And once those redemptions got limited, the psychological problem only began. We pointed this out way back in the fall last year with the UBS funds. Remember those? That's what got all this started. And here we are. Because now investors know for certain that liquidity exists only on paper. And that has created a feedback loop. Once investors believe a fund might limit withdrawals, and we've seen way too many examples of that already, they might start submitting redemption requests other than what they otherwise would have. But just get out to get the hell out. It's not quite a classic bank run, but it is very similar. And in private credit, the danger is not necessarily one giant overnight collapse. The danger is a slow motion liquidity squeeze where gates and queues, asset sales gradually expose the gap between reported values and market values. Where price discovery starts discovering uncomfortable pricing. Exactly what we're seeing all over the market and with increasing frequency. Stage 2 behavior getting even more stage 2. So now let's connect this to software. Because as I said, we have to start thinking about the software sector as maybe the private credit equivalent of subprime mortgages. Now subprime mortgages were not the 2008 crisis, but in many ways they were the spark that lit the fuse to it. And we're getting the sense that the same thing is happening here with software. There's a spark that is leading down the road toward the toxic waste status. For years, software companies were treated as premium borrowers in private markets. The pitch was simple. Recurring revenue, subscription contracts, high gross margins, strong customer retention and scalable business models. Private equity firms, they bought software companies at higher and higher valuations. Private credit lenders finance those deals. Everybody liked the story because the companies look stable, asset light and predictable. But there was a problem. A lot of these businesses were priced and financed for a world that just didn't exist, where growth would continue unchallenged forever. Valuations would stay high, refinancing would remain available and software margins would remain protected. Then the recovery really failed to take off. Growth slowed at best. It forgot how to grow. And now artificial intelligence is raising a much bigger question. What if some of these software companies aren't quite as durable as investors had assumed? AI threatens parts of the software market in two different ways. First, it can reduce the value of existing products by making it easier and cheaper to build alternatives. And second, it can pressure pricing. If customers believe that AI tools can replace expensive software subscriptions, then revenue that once looked recurring may not be as sticky as advertised. And that matters enormously for those who lent the loans. For private credit. Because lenders underwrote many of those loans based on recurring revenue and profit assumptions. And if those assumptions weaken or just disappear, leverage goes up, interest coverage goes down, refinancing gets harder, and the loan that looks safe at par suddenly looks like a lot less than par. And this is why software exposure is now becoming a stigma. And according to Bloomberg, firms including Blackstone and Guggenheim have been involved in new credit products where a key perk to those products is reduced software exposure. That's the market speaking. When a firm markets a security by saying it has less exposure to a certain sector, it means investors are asking about that sector. Not just asking, they're openly worried about it. They want to know they're not buying a portfolio with what everyone increasingly sees as toxicity. In 2006, subprime was a yield opportunity. By 2008, subprime was utter toxic waste. Now that doesn't mean software loans are the same as subprime mortgages. As I said, they're not identical. The structures are different. The borrowers are different. The financial system is way different than it was back then. But the psychopsychology, very familiar, and that's the part to focus on. Where the perception of toxic waste sticks first and most obviously. An asset class that goes from popular to questioned to avoided and then outright toxic. And software and software loans appear to be running down the path toward that toxic waste status. And if they get there, that's when you start talking about contagion. First of all, within the private credit space, and then further into stage three, maybe not just inside of private credit, but spilling over outside too. And this may be the most important signal in the entire story. Not defaults, not downgrades, not a single redemption. The signals that firms are now trying to raise money by saying, this portfolio has less of the thing everyone is afraid of. That tells you the market has seriously changed. During the boom, software exposure was a badge of quality. It meant growth and recurring revenue, not to mention probably a private equity sponsorship. It meant the borrower was part of the modern economy. Now, less software is being marketed as a key feature. It really is a dramatic reversal. And reversals like this matter because credit markets are built on confidence. If investors stop wanting this type of exposure, then lenders stop making those loans. And if lenders stop making those loans, borrowers can't refinance. If borrowers can't refinance, more loans become distressed. And if more loans become distressed, investors become even more worried. And they see that they have even more reason to be worried. That's the credit cycle. The concern is not just that some software loans will lose money, because of course some of them are going to. The bigger concern is that an entire category of the private credit space and private credit collateral becomes harder to finance, harder to sell, and harder to value. Because once buyers say, I don't want that exposure, price discovery, which gets forced more and more on the system, gets to be uglier and uglier. A loan that was marked 95 may only clear at 80 or 70, perhaps 65 as we saw the other day. Or maybe there's no real bid unless the seller accepts completely distressed pricing. So that creates a valuation problem for every fund holding similar loans. And we know only too well, the market knows only too well, private credit funds are stuffed with software loans. That's the sector they all went to for volume. So if one manager says its software loan book is worth close to par, but new market buyers are demanding steep discounts, investors are going to start asking even more uncomfortable questions. Are those marks real? Are the losses being recognized? Are funds using PIK, amendments, and maturity extensions, selective defaults to delay the truth? And if investors don't trust the marks, redemptions get worse and worse and worse. That's how a credit issue becomes a bigger liquidity issue, bigger than one that we already have and we already see, and we're already documenting from all over the place. So the software issue is the first big pressure point. Therefore, that's the analogy to subprime mortgages in 2008. The market has identified this pressure point, and once it does and seems like it gets validation of that identification, it starts to look elsewhere because, again, human nature. Plus, let's face it, we know the bubble behavior. That was what really started this to begin with. Tricolor, first brands, all the frauds, the cockroaches that showed up, really established. There is a downside here, not just limited to software, the downside in just broad bubble behavior. So now we've found it in software. We think we found it in software. Now it's time to look everywhere else to see what's really there. If software borrowers were overvalued this badly, what about health care services or business services? What about consumer companies that were bought by private equity? What about roll-ups that depended upon cheap debt? How about companies using PIK interest because they can't pay cash? Once investors start asking these questions, the entire asset class gets repriced, and the repricing doesn't need to happen through a public market crash. It can happen very quietly. Banks reduce lending against private credit portfolios. We've seen that. Insurance companies move up in credit quality. We've seen that. Pension funds start trimming their allocations. We've seen that. Wealth platforms slow fundraising. Secondary buyers demand discounts. Ratings agencies become more cautious. We've seen some of that. Regulators ask more questions. That is definitely happening too. And each piece by itself looks manageable, but together they become the dreaded credit crunch. That's the real risk. Not that every private credit vehicle collapses tomorrow. The risk is that credit availability, therefore liquidity, shrinks across the parts of the economy that came to depend upon these private lenders, these shadow banks. If private credit lenders pull back, those companies may have nowhere else to go, and they're the ones that are most vulnerable to a weakening economy. Just look at the latest income and spending data that we got earlier today. Banks may not want to lend to them. Bond markets may not be open. Loan markets may demand much higher yields, and private credit funds that are dealing with redemptions just won't have the capacity or willingness to extend more money. That's when financial stress becomes something a lot bigger and potentially more damaging. So what happens if this situation keeps escalating, keeps getting worse? What we're really talking here in this video is about Stage 2 behavior. In fact, Stage 2 behavior that's getting deeper into Stage 2. What happens if we do continue to progress further into Stage 2 and maybe even get to Stage 3? Now, Stage 1 is what we've already seen, the bad headlines, rising redemptions, and growing concern about software exposure. Stage 2, where we are now, funds limiting withdrawals, institutional investors pulling back, new securities being marketed as safer because they avoid software, the subprime mortgages of the 2020s, and more scrutiny around valuations. Stage 3, where it gets dangerous. In Stage 3, the issue stops being isolated credit stress and becomes a broader funding problem. And here's how that could play out. First, redemption queues build up. Investors who can't get out immediately, they keep submitting their requests. New investors hesitate to come in because they don't want to enter a fund with a redemption backlog, and that's what we've seen already. Second, managers start selling assets. But they don't necessarily sell the worst assets. They sell what they can sell, and that often means the better loans that leave the portfolio or the hardest-to-value stuff remains in it, which doesn't make it look all that great. Third, secondary market prices become the new reality. If loans trade at 80, 70, or 60 cents on the dollar, other funds holding similar assets are going to face pressure to mark down their portfolios, which will not lead to anything good. Fourth, banks and leverage providers tighten up their terms more than they already have. If collateral values are being questioned, and they are, lenders are going to demand more margin, lower advance rates, and additional collateral calls, and that forces even more asset sales. Fifth, borrowers lose access to refinancing. Companies that assume they could extend maturities or raise new debt discover the market's close to them. Defaults really start to rise. PIK interest stops being a temporary solution, and becomes evidence of distress. And sixth, institutional investors reassess the entire allocation. Pension funds, insurance companies, and wealth platforms don't need to abandon private credit entirely to cause significant trouble. They only need to slow commitments and reduce their exposure or even just demand better terms. That alone can starve this massive money machine. And the lack of daily pricing delays panic on the way down, but it also delays trust from returning, hopefully trying to recover. In public markets, ugly prices eventually clear the market. In private markets, nobody knows exactly where the clearing price is until someone is forced to sell. That uncertainty can freeze activity and everything else. And frozen credit markets hurt the real economy and can force the system into a downward spiral, creating volatility all over the place, just like we saw, remember 2024? The Japanese carry trade crack up? What was that all about again? Bad economy, institutional investors who reach for yield and then started to regret it. For a short while, even the stock market couldn't escape the shadow credit vortex. That's kind of what we're talking about here, looking down the road. So the Swiss pension fund story is important because more proof, more evidence, more emphasis, institutions and not just institutions in the US or institutions all around the world are wrapped up in it. And as they're wrapped up in it, we get more and more of a sense of that toxic waste tinge. The software loan panic is not important because every software company is doomed. It's important because investors are now really starting to treat an entire category of private credit exposure as something to avoid. And the less software marketing pitch is not just a product detail, it's a warning sign. It further proves that private credit has moved from confidence to outright suspicion, from yield opportunity to risk management, from buy to premium income to show me what's actually inside your portfolio. That's how credit bubbles really unwind, slowly at first, then through gates and discounts, valuation disputes, refinancing failures, and finally a broad pullback and lending. Private credit promised high returns with low volatility. Now investors are discovering that low volatility may have simply meant low visibility. And as more visibility arrives, the picture is getting uglier. So the question now is how much bad lending was hidden during the boom, how much of it is tied to sectors like software, and how many investors will ask for their money back before the market finds out what these assets are really worth. So the question now is how much garbage lending was hidden during the boom, how much of that was like software, and what happens once markets are forced to start discovering prices? Because once these private assets start to get markets and market prices, the reality can get pretty brutal, especially when the big guys want out. Now we've already seen evidence that outflows are outpacing inflows already, and that is forcing asset sales and private credit, and that is the background behind everything we just went over, and it's in the video link below. As always, thank you very much for joining me. Huge thank you, Uridal University members and subscribers, and until next time, take care.