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Private credit funds are weirdly skewed towards software borrowers, which might make for squeaky bum time come redemption. But we can’t easily track the market’s view as to their worth, given they are only periodically valued (and, often, by the same folks whose job it is to calm the nerves of end investors).
We can look at public market credit data to observe in (almost) real-time how creditors understand the emergent risks to firms from AI disruption. But among issuers of US investment grade bonds these risks are currently priced as few and far between.
How about leveraged loans? This asset class with big overlaps to private credit in terms of issuer type and credit risk. But it also has real-time secondary market pricing that we could, in theory, track.
The leveraged loan market is large. Looking just at Europe and America, it has around $1.7tn par outstanding, making it larger than either the high-yield bond market or the non-business development company portion of private credit.
Sadly, we don’t have the data licenses to provide you with a breakdown of the market granular enough to show quite how the market has digested SaaSmageddon on an issuer-by-issuer basis.
But we do have stats for sector splits. And these suggest that in a world of mark-to-market rather than mark-to-model, loan investors are plenty unsettled by recent developments:
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The Morningstar European Leveraged Loan index contains more than €335bn face value of loans from almost 400 issuers. Only 36 of these issuers are classified as being issued by companies in the ‘Software and Services’ subsector, and between them they’ve borrowed just over €30bn in index-eligible debt, making software the third-largest subsector. These loans have lost investors just over five per cent so far this year, and have helped drag the market total return into the red.
If you hover your mouse/smoosh your fingertip over the treemap above you’ll see that loans in the software subsector trade at an average 91.6 cents on the Euro.
How do things look in the larger US market? Similar.
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At over $1.5tn, the US index is around four times the size of its European sibling, and US software loans constitute around double the European index’s share. US software loans haven’t lost investors quite so much money this year as European ones. And the rest of the US market consists of slightly-higher-rated issuers that look to have clipped their coupons and done OK.
Where does this leave investors’ year-to-date performance? We doubt they’ll be delighted by their modest losses. But they’re hardly end of days stuff, at least so far.
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What’s the read across to private credit? Not great. But also not super-clear.
Readers will recall that, like the Morningstar US leveraged loan index, BDCs (which we understand to be a decent proxy for the private credit market in general) have pretty much their largest sector exposure to software firms. And a Bloomberg analysis suggests that the official figures, moreover, understate the true size of the exposure.
But leveraged loans tend to be issued by larger more established firms. And so we’d expect ruptures in the software market to be more keenly felt by smaller firms borrowing from private credit funds. We’ll be the first to admit that this is a hand-wavy take.
Historically, analysis from S&P suggests that private credit funds have been quick to restructure loans so that they don’t turn into hard defaults. Ways in which this might happen would include extending the term of a loan, or by dropping the requirements to pay interest payments in cash in part of in full.
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And in an environment where investors are falling over each other to throw money at private credit — and one of the biggest problems they have is sourcing new borrowers — we can see how this might have made sense for them.
But given the recent change in mood music, it will be interesting to see whether this continues to be the case.
Further reading:
— Investors sour on listed credit funds over AI hit to software sector (MainFT)
— Will software eat the creditors? (FTAV)
— US investment grade credit markets care about the tech wreck, just not very much (FTAV)
— It’s not a default if you never ask for cash — right? (FTAV)
— How bad could private credit default rates get? (FTAV)
