Private credit markets are facing increased scrutiny as concerns mount over the potential impact of artificial intelligence on software companies, a key borrower group for these lenders. A recent sell-off in software stocks, triggered by new AI tools unveiled by Anthropic, has rattled investors and raised questions about the future viability of traditional software business models.
The software industry came under renewed pressure last week following Anthropic’s release of nearly a dozen plugin tools for its Claude Cowork AI assistant. These tools are designed to automate complex professional tasks – spanning sales, legal analysis, and data processing – traditionally handled by software companies, sparking fears of disruption and diminished demand. Shares of companies perceived as vulnerable to this shift have subsequently declined.
The impact is already being felt in the market for private credit, where firms have significantly increased their exposure to software companies in recent years. Ares Management fell over 12% last week, while Blue Owl Capital lost over 8%. KKR declined almost 10%, and TPG lost about 7%. Apollo Global and BlackRock experienced more moderate declines, falling over 1% and 5% respectively. In comparison, the S&P 500 declined by about 0.1%, while the Nasdaq fell 1.8%.
The concerns center on the potential for AI to erode the revenue streams of software companies, leading to cash flow problems and defaults on their loans. UBS Group has warned that, in a scenario of aggressive AI disruption, default rates in U.S. Private credit could climb to 13%, significantly higher than the stress projected for leveraged loans and high-yield bonds, which UBS estimates could come to around 8% and 4%, respectively.
Private credit loans to a lot of software companies. If they start going south, there’s going to be problems in the portfolio.
Jeffrey C. Hooke
Johns Hopkins Carey Business School
“Enterprise software companies have been a favored sector for private credit lenders since 2020,” PitchBook wrote in a report last week. The firm noted that many of the largest unitranche loans – a popular structure in the private credit market – have been extended to software and tech companies. Software currently accounts for approximately 17% of investments by deal count within U.S. Business development companies, second only to commercial services.
This exposure is particularly concerning given the prevalence of Payment-In-Kind (PIK) loans within the software sector. PIK loans allow borrowers to defer cash interest payments, offering flexibility for fast-growing companies. However, they also carry increased risk, as deferred interest can quickly become a credit problem if a borrower’s financial performance deteriorates. Kenny Tang, head of U.S. Credit research at PitchBook LCD, highlighted this risk, stating that AI disruption could be a credit risk for private credit lenders for some of its Software & Services sector borrowers.
The current unease builds upon existing concerns within the $3 trillion private credit industry regarding leverage, opaque valuations, and the potential for isolated problems to escalate into systemic issues. JPMorgan Chase CEO Jamie Dimon cautioned late last year about “cockroaches” in the private credit market, suggesting that a single borrower’s distress could signal broader underlying vulnerabilities.
The situation is further complicated by the lack of transparency in the private credit market. Moody Analytics’ chief economist Mark Zandi noted that It’s difficult to fully assess the risks due to the sector’s opacity, but the rapid growth in AI-related borrowing, mounting leverage, and lack of transparency are considerable “yellow flags.” “There will surely be significant credit problems, and while the private credit industry is probably currently able to absorb any losses reasonably well, this may not be the case a year from now if the current credit growth continues,” Zandi said.
Ares Management CEO Michael Arougheti attempted to downplay the firm’s exposure, stating that software loans comprise only about 6% of its total assets and less than 9% of its private credit assets under management. He added that Ares primarily lends to profitable software firms with strong cash flow and maintains low borrowing levels, resulting in minimal problem loans.
The unfolding situation underscores the growing interconnectedness of the technology and financial sectors, and the potential for rapid technological change to disrupt established business models and financial markets. While the full extent of the impact remains uncertain, the recent market reaction signals a heightened level of caution among investors and lenders regarding the future of software and the private credit market’s exposure to this sector.
