The software sector turmoil that has recently unsettled private markets is approaching a major test, with a significant wave of debt maturities on the horizon. By the end of 2028, over $330 billion in high-yield bonds, leveraged loans, and software and technology debt associated with business development companies is set to mature. A substantial portion of this debt is linked to companies owned by private equity investors. When these firms seek refinancing in the coming months, they will face multiple headwinds, ranging from concerns that artificial intelligence could undermine their products to risks that Middle East conflicts are pushing borrowing costs higher. According to informed sources, some private credit funds are directly avoiding software sector borrowers to reduce their exposure to the industry. Concurrently, several planned sales of software companies by private equity firms have stalled. Researchers from MSCI Inc. stated, "Software borrowers from private credit funds carry higher leverage and rely more heavily on future growth expectations, making them more vulnerable to adverse shocks." The following charts highlight the pressure that faltering software bets are placing on private equity and credit markets. Over the past 15 years, private market managers have allocated hundreds of billions of dollars to the software industry, betting that the software-as-a-service business model would deliver high growth and stable cash flows. In recent years, software and technology services have accounted for nearly half of all private equity deals, far surpassing any other sector. For nearly two decades, this concentration risk was justified by market-beating returns from relevant funds, which often promoted their focus on sectors like technology. However, in recent years, as more capital has flooded into the sector, the associated premium has diminished. During the post-pandemic period of low interest rates, private markets accelerated their bets on software, sending valuations soaring and driving record merger and acquisition volumes fueled by private equity and venture capital in 2021. These deals are now dragging down overall performance, as inadequate hedging has led to surging borrowing costs and called valuations into question. Meanwhile, the rapid advancement of AI tools over the past 18 months has made heavy concentration in a single sector appear increasingly unwise. Nevertheless, many private market managers still believe these companies will demonstrate resilience. However, investors are showing signs of concern: many are accelerating withdrawals from direct lending funds, prompting managers to restrict redemptions on some semi-liquid products. More broadly, valuations and debt prices for companies heavily reliant on software are declining. In the leveraged loan market, the premium typically enjoyed by tech loans has completely vanished this year. This mounting pressure is ill-timed for credit investors. Overall, more than $140 billion in technology company debt is maturing in 2028, with firms potentially beginning refinancing efforts as early as the second half of this year. Michael Anderson and Steph Choe of Citigroup noted that this maturity peak primarily involves loans originated during the low-rate environment of the pandemic. "One-third of these loans still have a 2021 credit origination date, meaning the issuers haven't demonstrated their ability to access capital markets for years. The average price for loans issued in 2021 and maturing in 2028 is $83.40, indicating significant stress." Falling prices for software-related leveraged loans serve as a leading indicator of deterioration in the private credit market, where valuations often lag significantly behind public markets. Typically, as loan prices fall, a growing number of private credit borrowers face strain because their earnings are insufficient to cover interest costs. Bruce Richards, Chairman of Marathon Asset Management LP, stated this week that default rates on direct loans in the software sector could reach as high as 15% over the next few years. However, others are less concerned. Vivek Bantwal, Co-Head of Global Private Credit at Goldman Sachs Asset Management, said that although many private credit managers have software and technology exposures as high as 30% in their portfolios, their loans are usually senior in the capital structure, offering more protection in a restructuring. For business development companies that lend to small and medium-sized enterprises, an earlier test is imminent, arriving well before the 2028 maturity peak. Over $31 billion in software-related debt is maturing this year. Ron Kahn, Co-Head of Global Valuation & Opinion at Lincoln International, said that with rising financing costs, "higher interest expense will hit" weaker companies, meaning they will require additional equity support from their sponsors. He noted that some private equity managers will consider selling companies from their portfolios, hoping to fetch prices sufficient to repay debt. In other cases, "private credit and private equity will just kick the can down the road. Lenders will get higher pricing, and companies will get time to adjust." A concern for regulators is that private credit firms have been using a tool known as Payment-in-Kind interest to mask weakness in their portfolios. PIK allows borrowers to defer interest payments until the debt matures. Lincoln uses the accumulation of "low-quality PIK" during a loan's life as a proxy for private credit default rates. The firm estimates that approximately 6.4% of direct loan borrowers had low-quality PIK in the fourth quarter of last year, up from 2.5% at the end of 2021. Lincoln also stated that the loan-to-value ratios for these borrowers are soaring, further indicating signs of stress. Kahn said, "For years, there has been a symbiotic relationship between direct lenders and private equity," but now sponsors are indicating they will not continue supporting companies if they don't see further value. "Everyone is looking out for their own interests."
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