AI shockwave spreads from the software industry to the bond market: biggest creditors Ares and KKR suffer sharp stock drops, default rate could soar to 13%

The disruptive wave brought by artificial intelligence technology is spreading from the software industry deep into financial markets, and the private credit debt market faces unprecedented uncertainty. As AI technology begins to threaten the business models of traditional software companies, the private credit debt investment portfolios—main sources of industry financing—are undergoing serious risk revaluation, sparking concerns about the asset quality of the private credit debt industry with a scale as large as $3 trillion.

Last week, a new AI tool released by artificial intelligence company Anthropic triggered a sell-off in software data suppliers’ stocks, and this shock quickly spread to the asset management sector. The market fears that AI technology will weaken borrowers’ cash flows and increase default risks; asset management firms with large private credit debt businesses suffered sharp declines in their stock prices. Ares Management shares fell more than 12% last week, KKR fell nearly 10%, Blue Owl Capital dropped over 8%, and TPG slid about 7%. By contrast, the S&P 500 index only dipped about 0.1% during the same period.

This market turmoil highlights investors’ growing concerns over exposure to the private credit debt market. PitchBook’s analysis notes that the software industry has been a favored investment target for private credit debt institutions in recent years, and many large single-layer loans have been directed toward these companies. According to a WallstreetCN article, the software industry accounts for 17% of investment transactions among US business development companies (BDCs, a key source of funds for small and mid-sized enterprises in the private credit market), second only to commercial services.

UBS Group has issued a stern warning: if the disruptive impact brought by AI accelerates beyond borrowers’ adaptability, the default rate for US private credit debt could soar to 13% in a radical scenario. This forecast is significantly higher than UBS’s stress test estimates for leveraged loans (8%) and high-yield bonds (4%), indicating that the private credit debt market appears especially fragile when facing shocks from technological change.

Exposure to the Software Industry Raises Concerns About Credit Debt Quality

The private credit debt market's high concentration in the software industry means that any turbulence in the sector will be amplified. Anthropic’s new tool is designed to perform complex professional tasks—tasks that are at the core of many software companies’ fee-based services. This directly challenges the traditional moat of the software business and casts doubt on its future debt repayment capacity.

Jeffrey C. Hooke, a senior lecturer in finance at Johns Hopkins Carey Business School, points out: “Private credit debt has provided loans to a large number of software companies. If those companies’ businesses start to decline, problems will arise in the portfolio.” Hooke further notes that stress in the private credit debt sector existed even before AI-related concerns, with frequent liquidity problems and loan extensions—and the impact from AI undoubtedly adds a new risk layer to this already pressured industry.

Kenny Tang, head of US credit debt research at PitchBook LCD, believes that AI disruption could pose a credit debt risk for some software and service industry borrowers, depending on where companies stand on the AI technology curve. Those unable to keep pace with technological change will face tough challenges.

Payment-in-Kind (PIK) Loans Accumulate Risk

Aside from industry exposure, loan structure itself also intensifies potential risks. Kenny Tang notes that software and service companies hold the largest share of payment-in-kind (PIK) loans. This loan structure allows borrowers to postpone cash interest payments; while it’s often used to give high-growth companies a buffer period to build revenue streams, it’s extremely risky when borrowers’ financial health deteriorates. Once fundamentals weaken, deferred interest quickly transforms into a credit debt problem.

Mark Zandi, chief economist at Moody’s Analytics, warns that due to the opacity of the private credit debt market, it’s very difficult to fully assess its risks. Nonetheless, he stresses that the rapid growth of AI-related lending, rising leverage, and lack of transparency are very clear “yellow warning flags.” Zandi expects serious credit debt problems to emerge, cautioning that if the current credit debt growth continues, the industry may not be able to absorb losses as well as it does now in a year’s time.

Systemic Rise of Hidden Risks

This market revaluation triggered by AI has occurred against the backdrop of the private credit debt sector itself facing multiple questions. This $3 trillion market has long attracted attention due to high leverage and opaque valuations. JPMorgan CEO Jamie Dimon had warned about hidden dangers in the private credit debt market at the end of last year, saying stress at a single borrower might signal more hidden trouble.

PitchBook mentioned in a report last week that enterprise software companies have been the darlings of private credit debt institutions since 2020. Now, however, the market must prepare for AI-driven disruptive impacts. This uncertainty is forcing investors to rethink merger and acquisition deals financed by opaque, non-liquid loans, especially those targets highly exposed to technological change risks.

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