The surge in loan defaults in the U.S. software industry is leading to a "software-PE" death spiral

The American software industry is facing a credit crisis triggered by artificial intelligence.

On Thursday, according to data compiled by Bloomberg, over $17.7 billion in loans to tech companies have fallen into bad debt levels over the past four weeks, with the total amount of bad debt in the tech industry soaring to approximately $46.9 billion, the highest level since October 2022. This crisis, referred to by the market as the "SaaS apocalypse," is rapidly transmitting from the stock market to the private credit sector.

The core driving force behind this sell-off is the market's concern about AI disrupting traditional software business models. The Software as a Service (SaaS) industry is seen as particularly vulnerable, as AI is replacing traditional software functions such as coding and data analysis.

The impact of this crisis is spreading, with distressed debt including loans to healthcare software companies FinThrive and Perforce Software, both backed by private equity firm Clearlake Capital.

Bank of America analysts noted that approximately 14% of leveraged loan market assets are exposed to the tech industry, while this proportion rises to 20% in the private credit sector. For collateralized loan obligations (CLOs) that package leveraged loans into bonds, the software industry accounts for between 11% and 16%. The current private credit market is experiencing two shocks: the collapse of the logic behind software company loans and the waning attractiveness of private credit.

Rapid Deterioration of Software Industry Debt

Bloomberg Intelligence data shows that the $17.7 billion in tech company loans that have fallen into bad debt levels over the past four weeks are primarily concentrated in the Software as a Service sector. Bad debt levels refer to debts yielding more than 10 percentage points above the benchmark Secured Overnight Financing Rate (SOFR).

In addition to the already distressed debt, more software company loans are approaching pressure levels. Leveraged loans for human resource management software provider Dayforce and call center technology company Calabrio, both held by private equity firm Thoma Bravo, are nearing the brink of distress. Loans for data integrity software company Precisely, jointly held by Clearlake and TA Associates, fell 8 cents this week.

Jack Parker, a portfolio manager at Brandywine Global Investment Management, described the current situation as a moment of "sell first, ask questions later." He stated, "This is indeed painful for the industry, as people are broadly selling off all assets in this sector without paying much attention to how much AI can disrupt these businesses and how long it will take."

Bank of America analysts found that since January 9, 80% to 90% of issuers in the enterprise software and technology services sector have experienced negative price returns. The bank referred to January 9 as the "turning point" for the industry. Analysts wrote in a report: "As AI advances rapidly, there are growing concerns that AI may threaten software and service providers, potentially pressuring their revenue streams if not completely eliminating them."

Private Credit Faces Dual Dilemma

The challenges in the software industry are sending shockwaves through the private credit market. Alternative lending institutions such as Blue Owl, Runway Growth Finance, and Golub Capital have begun to see their stock prices plummet in sync with the software industry.

Data from Bank of America analyst Ebrahim Poonawala's team shows that, using the technology category as a broad proxy, software appears to be one of the largest industry exposures for business development companies (BDCs). Raymond James analyst Robert Dodd points out that the actual exposure may be even higher, as loans to software companies are often classified by end markets. For example, a company providing SaaS for healthcare may be categorized under "healthcare" rather than "technology" or "software."

Analysis suggests that the private credit market is undergoing two simultaneous "unwinding" processes.

First, the logic of lending to software companies has collapsed. Annual recurring revenue (ARR) was once seen as providing stable, bond-like cash flows, and this predictable payment stream justified lending even in cases of negative free cash flow. However, this argument relies on the belief that subscription revenue will remain stable. When business models suddenly face obsolescence risks, the "stable annuity" turns into a binary bet.

Second, the appeal of private credit itself is waning. As public market yields continue to catch up, the promised "liquidity premium" no longer seems as attractive. The so-called isolation effect—no daily mark-to-market, limited volatility, and calmness in storms—becomes harder to sell when defaults are now seen as a real risk, and every headline in the market seems related to areas of significant exposure held.

A Death Spiral is Forming

Jeffrey Favuzza from Jefferies' equity trading department describes the current situation as a "SaaS apocalypse," noting that the current trading style is entirely panic selling of the "get me out at any cost" variety, with no signs of stabilization in sight.

Analysis from JP Morgan and Goldman Sachs shows that the market is experiencing unprecedented divergence: on one side are semiconductor companies viewed as beneficiaries of the AI supercycle, while on the other side are software companies seen as the biggest losers. This divergence is forming a dangerous negative feedback loop.

As software equity valuations plummet, private credit institutions face pressure to reassess their balance sheets, which may lead to tighter credit conditions. This, in turn, will further squeeze the growth space of software companies already facing existential crises. Loan companies trading at distressed levels will find it difficult to access traditional debt markets, exacerbating financing difficulties.