Private Credit Should Worry About a Singularity in Software Debt

by Paul J. Davies of Bloomberg News, 2/18/26

Artificial intelligence fears have ripped through stock and bond markets, but investors in loans and private credit are still playing catch-up. Part of the problem is working out which areas of the debt market are exposed to disruption and which aren’t. Because fund managers apply industry categories in varying ways, some companies that are really software sellers are misclassified as anything from retailers to food producers, according to Bloomberg News.

Different business models within the software industry — whatever their labels — will prove more or less vulnerable to AI disruption. Investors in loan-focused mutual funds, collateralized loan obligations, business-development companies (BDCs) and private-credit funds all have work to do to comprehend their holdings. Only then can they start to assess which credits might be at risk of default, or refinancing problems, or other shenanigans that could lead to losses down the track.

Within the relatively transparent world of BDCs, at least 250 loans to software firms worth more than $9 billion were categorized as some other kind of business by one or more of those often publicly-traded vehicles that invest in private credit, Bloomberg News found. A pricing-software business called Pricefx was labelled “business services” by one lender, while Restaurant365, which supplies software to eateries, was called “food products” by another. Such idiosyncratic classification doesn’t make the business more likely to be blown up by AI — but it sure doesn’t help investors.

In fact, software is the biggest single industry among private-equity-backed businesses, however you cut it. In mid-market CLOs, which package up loans to smaller companies and are a good proxy for private credit funds, software makes up 19% of portfolios, according to analysis by S&P Global Ratings. Another ratings company, KBRA, categorized borrowers using its own data on mid-market CLOs, BDCs, and bonds backed by companies that got credit based on their recurring revenue. It found that 22% of this debt by value was owed by software firms.

Private equity and private credit managers have fought back against the disruption fears stalking their assets. Several listed managers, for example KKR & Co. and Apollo Global Management Inc., said on earnings calls this month that they had already cut software exposures through sales over the past couple of years. Others, including Ares Management Corp., said the share of their portfolios invested in the sector was significantly smaller than the industry average.

Bankers and other managers, meanwhile, have been highlighting the low loan-to-value ratios of many deals. Marc Lipschultz, co-chief executive officer of Blue Owl Capital Inc., told shareholders two weeks ago that its software loans on average were granted at just 30% of the borrowers’ enterprise values (the sum of their equity and debt). Even after the recent selloff in public software stocks, companies are still worth more than two years ago, Lipschultz said, suggesting the same applied to private-equity backed companies in the same space.

“If the software business evolves over time, well, that'll be to the benefit or loss of the equity holders,” he said. “But we're in a position, we think, to continue to get our capital back and earn a very strong return.” For lenders to really lose significant money, more than 70% of the total value of these businesses would need to be destroyed, he added. In other words, the equity would have to go to zero.

That’s fair up to a point, but there are problems with this argument. Judging loans against enterprise value is a risk in itself, especially if the deals were done in the recent vintage of peak valuations. A better guide to creditworthiness is the value of debt as a multiple of earnings before interest, tax, depreciation and amortization. The indicators there aren’t great. Software companies have the highest median leverage ratios among mid-market borrowers, according to S&P. They also have the lowest interest coverage ratios, although both ratios have improved slightly in recent years.

A subset of software firms has even higher leverage, because they are younger businesses that divert more of their earnings into marketing and sales to generate faster growth. These companies borrowed against the value of recurring revenue from existing clients rather than against Ebitda, with the idea that they could slash spending to repay debt if required. That’s an inherently riskier strategy, but the creditworthiness of these businesses has also been improving in the past couple of years.

The past isn’t necessarily a guide to the future, however. About one-fifth of the private-equity backed companies exposed to AI disruption will need to refinance debt in 2028, according to strategists at UBS Group AG. The recent wave of withdrawals from BDCs shows fresh funding might become harder to find. Borrowers would face higher interest costs if their businesses look under pressure when they need new debt. That in turn could cut the value of their equity and make owners less willing to inject more capital to keep companies afloat — hence some are predicting an increase in defaults across private credit and leveraged loans beyond what has been acknowledged so far by investors. Others, however, already think the selloff in loans has gone too far: Carlyle Group Inc., BlackRock Inc. and others have begun buying discounted software debt, Bloomberg News reports.

Another risk among large-scale borrowers where multiple lenders are involved, is more creditor-on-creditor violence, but that’s less of a risk across mid-market private debt.

Any resulting losses aren’t likely to remain contained within these corners of the credit market. With a combined $3.5 trillion worth of debt, leveraged loan and private credit markets are big enough to matter to broader debt and equity markets in the worst scenario, where systemwide losses could amount to $275 billion, according to UBS strategists.

If losses spike too quickly, that could lead to a wider financing crunch. “In a tail outcome, the knock-on effects for all issuers attempting to access credit — including hyperscalers and AI related firms — could be significant, potentially undercutting capital spending, investment plans, and ultimately the AI boom itself,” UBS strategists wrote last week.

Maybe we’re headed for a debt-market singularity, where the disruption-inspired selloff contains the seeds of the AI bubble’s own bursting. For investors, the choice is run away from the risk as many are doing in stock markets — or really dig into the stresses their debt funds actually face.

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Bloomberg News provided this article. For more articles like this please visit bloomberg.com.

Private Credit Should Worry About a Singularity in Software Debt

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