Private credit’s software blind spot sparks fresh fears for $3 trillion sector

Private credit markets face new uncertainties as AI-powered tools begin to pressure software companies, a key borrower group for private lenders.

The software industry came under renewed pressure last week after AI firm Anthropic unveiled new AI tools, sparking a sell-off in software data provider shares.

The AI ​​tools developed by Anthropic are designed to perform complex professional tasks for which many software companies already charge, raising new concerns that AI could undermine traditional software business models.

Shares of asset managers with large private lending franchises have tumbled this week as investors worry about how artificial intelligence could disrupt borrowers’ business models, pressurize cash flows and ultimately increase default risks.

Ares Management It dropped by over 12 percent last week Blue Owl Capital It lost over 8 percent. KKR fell almost 10%. KPI lost approximately 7%. Apollo Global And Black Rock fell to over 1% and 5% respectively. For comparison, S&P 500 fell about 0.1%, while the tech-heavy Nasdaq fell 1.8%.

The moves highlight a growing unease in the private credit market, which must now prepare for the impact of AI-induced disruption on the software industry, which is heavily exposed to acquisitions financed by opaque, illiquid loans, market watchers say.

“Enterprise software companies have been a preferred sector for private lenders since 2020,” PitchBook wrote in a report following this negativity last week. he wrote, adding that many of the largest unit loans (two or more loans bundled together) to date, a favorite structure of the private loan market, have been issued to software and technology companies.

Software accounts for a significant portion of loans held by U.S. business development companies, accounting for about 17% of BDC investments by deal count, second only to business services, according to PitchBook data.

This risk could be costly if AI adoption occurs faster than borrowers can adapt. UBS Group has warned that in an aggressive disruption scenario, default rates on US private loans could climb to 13%, significantly above the stress projected for leveraged loans and high-yield bonds; UBS’s estimates could be around 8% and 4% respectively.

“Private credit loans to a lot of software companies,” said Jeffrey C. Hooke, a senior lecturer in finance at Johns Hopkins Carey Business School. “If they start going south, there will be problems in the portfolio.”

But Hooke said tensions in private lending predated the latest AI concerns and pointed to problems with liquidity and loan extensions. “A lot of private credit funds have had problems liquidating their loans,” he said, adding that the recent developments have simply added another layer to a sector already under pressure.

This new warning list, Latest concerns in the 3 trillion dollar industry Excessive leverage, opaque valuations and the risk of isolated problems turning into systemic ones JPMorgan’s Jamie Dimon warned about the ‘cockroaches’ of private credit late last year, warning that stress on a borrower could signal further hidden problems.

“AI disruption could pose a credit risk to private lenders for some borrowers in the Software and Services sector and perhaps not for others because it depends on which ones are behind the AI ​​curve and which ones are above it,” said Kenny Tang, head of U.S. credit research at PitchBook LCD.

Tang added that software and service companies account for the largest share of payments in kind (PIK). Loans refer to arrangements where borrowers can delay paying cash interest. Although PIK structures are often used to give fast-growing companies time to generate revenue and cash flow, they become risky when the borrower’s financial position weakens. He said that in this case, the deferred interest could quickly turn into a credit problem.

Mark Zandi, chief economist at Moody Analytics, said it was difficult to grasp a full assessment of risks in the sector due to the sector’s lack of transparency, but noted that rapid growth in AI-related debt, rising leverage and a lack of transparency were “yellow flags” worth noting.

“There will certainly be significant credit issues, and while the private credit sector is probably well positioned to absorb any losses now, that may not be the case a year from now if current credit growth continues.”