Episode summary
The Risks of Private Credit's Software Exposure
Thoughts on the Market (Morgan Stanley)
· · Hosts: Vishy Tirupattur, Vishwas Patkar
Summary
Private credit’s exposure to software is large, but the risk is concentrated in parts of the market that are less transparent and more leveraged than public equities. The guest says about 80% of the software companies in the sample are private, with roughly 25% of BDC portfolios, 16% of the leverage loan market, and heavy representation in private credit CLOs tied to the sector. Because many of these businesses were financed through the 2020 and 2021 LBO wave, about 50% of borrowers are rated B minus or lower, and many deals carry front-loaded maturities that could create refinancing stress if disruption persists.
The guest argues the main concern is not just lower earnings, but the difficulty of separating software winners from losers as AI reshapes business models. Since many borrowers do not publish the same disclosures as public companies, BDC portfolios may need to be reassessed company by company, and BDC liability spreads have already widened. Even so, both speakers say the sector does not yet look systemic.
The host and guest point to much lower leverage than in the financial crisis, limited banking-system linkage, and a broader credit cycle that has remained restrained. Corporate debt to GDP has fallen over the last five years, balance-sheet leverage has been flat or lower in places, and M&A remains below trend, which should limit contagion from any further spread widening.
Key takeaways
- The guest says software is a significant credit risk because it is concentrated in private issuers, BDCs, private credit CLOs, and leverage loans rather than liquid public markets.
- About 50% of software borrowers are rated B minus or lower, and many deals from the 2020-2021 LBO wave have front-loaded maturities.
- The guest says BDC spreads should stay volatile and likely need to widen further as investors sort AI beneficiaries from AI losers.
- The host says the risk is significant but not systemic because BDC leverage is only about 2x and the banking-system link is remote.
- The guest says the broader credit cycle looks restrained, with corporate debt to GDP down over the last five years and M&A still below trend.
Notable quotes
“the software exposure in credit markets is large and understandably that's why investors are closely watching what's happening with software in the equity market”
“we estimate about 80% of companies are are private in in the whole sample set that we looked at”
“So about 50% of borrowers in the sector are rated B minus or lower”
“we expect credit spreads of BDC's to remain volatile for some time to come”
“this is a significant risk but not a systemic risk”
How the episode opens
Welcome to thoughts on the market. I am Vishitur, Morgan Stanley's chief fixed income strategist. I'm Vishwaspar, Morgan Stanley's US head of credit strategy.
While potential disruption from AI has been a key driver for markets last few weeks, the focus of investor Agitta has been in the software sector. On today's podcast, we will talk about software in the credit markets and its implications. It's Monday, March 2nd at 10:00 a.m.
in New York. Vishwas, let's start by understanding how the exposure in software manifests in the credit markets. How does it compare to software say in the equity market?
Yeah, so the software exposure in credit markets is large and understandably that's why investors are closely watching what's happening with software in the equity market. But what's interesting and important for investors to note is the exposure in credit is very different from what it is in equities. So for instance, a good chunk of exposure in the credit market is around private issuers.
So we estimate about 80% of companies are are private in in the whole sample set that we looked at and that's largely a function of the fact that software is not a big part of the more liquid spaces like investment grade and high yield but it is heavily represented in the more opaque parts of the market like leverage loans and your BDC's. So our analysis found that about 25% of BDC portfolios are in software closely followed by private credit CLOS and the leverage loan market was about 16%. So that's an an important distinction to keep in mind versus the equity market.
The second thing I would flag is because the software sector grew a lot in the loan market through the LBO wave of 2020 and 2021. It has a weaker credit quality skew to it than the overall market.
From the episode’s captions: roughly the first two minutes, lightly cleaned. Keep watching on YouTube →
Topics
- private credit software exposure
- credit risk
- fixed income strategy
- credit strategy
- software industry exposure
Companies and tickers mentioned
- MS
- Morgan Stanley
Watch the episode
Watch “The Risks of Private Credit's Software Exposure” on YouTube
Summary, takeaways and quote selection by Octagon. Quotes are short excerpts; the full conversation is in the episode.
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