Thoughts on the Market: The Risks of Private Credit's Software Exposure

Date: March 2, 2026
Hosts: Vishy Tirupator (Chief Fixed Income Strategist), Vishwas Partkar (US Head of Credit Strategy)

Episode Overview

This episode examines the increasing exposure of private credit markets—especially Business Development Companies (BDCs), CLOs, and leveraged loans—to the software sector, focusing on risks arising from AI-driven disruption. The hosts contrast software credit exposure with that of equities, dissect current vulnerabilities, and debate whether this constitutes a systemic risk to broader credit markets.

Key Discussion Points & Insights

1. Software Sector Exposure in Credit vs. Equity Markets

[00:09 – 02:28]

Credit Market Exposure Characteristics:
- A substantial portion of software sector credit exposure is concentrated in private issuers rather than public companies.
- "About 80% of companies are private in the whole sample set that we looked at." (Vishwas Partkar, 00:42)
- Unlike equities, software isn't dominant in investment grade or high yield corporate bonds, but is significant in more opaque spaces:
  - Leverage breakdown:
    - BDCs: ~25% of portfolios are in software.
    - Private Credit CLOs: High exposure, just below BDCs.
    - Leveraged Loan Market: ~16% exposure.
- This segment is heavily represented in less transparent, less regulated credit vehicles.
Quality and Leverage Metrics:
- The loan market’s software sector grew rapidly during the 2020-2021 LBO wave, resulting in:
  - Weaker credit quality: "About 50% of borrowers in the sector are rated B minus or lower."
  - Higher leverage and more front-loaded maturities, raising refinancing risks amidst uncertainty.
Key Insight:
The credit market’s exposure is distinct from equity markets, with more risk concentrated in private, less-liquid entities and often lower credit quality.

2. Assessing Risk in BDCs and Private Credit

[02:28 – 03:47]

Nature of BDCs:
- Publicly traded vehicles investing in the debt of small-to-medium private companies via non-bank channels.
- "What makes the assessment...challenging is that many of these companies are private companies without the reporting obligations of public companies." (Vishy Tirupator, 02:51)
- Lack of public disclosure (earnings, 10Ks, etc.) complicates risk assessment; individual deals must be "re-underwritten" to understand AI impact.
Current Market Dynamics:
- BDC liability spreads have widened, but full risk repricing and resolution are still underway.
- Expectation: BDC credit spreads will remain "volatile for some time to come" due to uncertainty over which companies will benefit from or be hurt by AI disruption.

3. Is This a Systemic Risk?

[03:47 – 06:05]

Magnitude of Leverage:
- "About 2x is the kind of leverage [in BDCs]. Compare that to... the financial system before the financial crisis... an order of magnitude smaller risk." (Vishy Tirupator, 04:10)
- While there is some indirect risk to banks via back-leverage, this is at a "risk remote" level due to high subordination.
Systemic Risk Assessment:
- Both hosts agree: While software exposure in private credit is "significant," it does not constitute a systemic risk.
- Recent credit cycles have been "restrained," with corporate debt to GDP falling for five consecutive years, flat or reduced leverage, and subdued M&A activity.
- "We have had a fairly restrained credit cycle... fundamentals are quite strong and that's why... the systemic contagion from any credit spread weakness... could be relatively muted." (Vishwas Partkar, 05:22)
Key Insight:
The risk is concentrated and meaningful, but unlikely to threaten the broader financial system due to lower leverage, smaller systemic links, and solid fundamental backdrops.

Notable Quotes & Memorable Moments

Private Market Dominance:
"About 80% of companies are private in the whole sample set that we looked at."
— Vishwas Partkar, [00:42]
On Credit Quality:
"About 50% of borrowers in the sector are rated B minus or lower."
— Vishwas Partkar, [01:23]
Challenge of Risk Assessment:
"Many of these companies are private companies without the reporting obligations of public companies. So no earnings reports, no 10Ks or Qs or broadly publicly available financials to look at."
— Vishy Tirupator, [02:51]
Systemic Risk Perspective:
"So my conclusion here is this is a significant risk but not a systemic risk."
— Vishy Tirupator, [04:29]
Historical and Macro Context:
"We have had a fairly restrained credit cycle... fundamentals are quite strong and that's why... the systemic contagion from any credit spread weakness... could be relatively muted."
— Vishwas Partkar, [05:22]

Timestamps for Key Segments

[00:09] Software sector exposure in credit markets: scale and nature
[01:15] Credit quality and leverage risks
[02:28] Specifics of BDC exposure and the challenge of private company risk assessment
[03:47] Is this a systemic risk? Comparing leverage and historical context
[05:22] Fundamentals of current credit cycle and systemic contagion outlook
[06:05] Summary: Significant risk, but not systemic

Summary Takeaway

Software’s growing presence in private credit vehicles like BDCs and leveraged loans presents focused risks—primarily due to lower-quality issuers, high leverage, and uncertain exposure to AI-driven disruption. However, these vulnerabilities are not large nor diffused enough to be systemic. The market may see spread volatility and a valuation reset, but broader credit fundamentals and low leverage should contain any fallout.

Transcript

A (0:00)

Welcome to Thoughts on the Market. I am Vishi Tirupator, Morgan Stanley's Chief Fixed Income Strategist.

B (0:05)

I'm Vishwa's Partkar, Morgan Stanley's US Head of Credit Strategy.

A (0:09)

While potential disruption from AI has been a key driver for markets last few weeks, the focus of investor agita 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, and at 10:00am 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?

B (0:37)

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 private 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 leveraged loans CLOs and BDCs. So our analysis found that about 25% of BDC portfolios are in software, closely followed by private credit clos and the leveraged loan market was about about 16%. So that's 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. So about 50% of borrowers in the sector are rated B minus or lower. So that's the lowest rungs of the rating spectrum. Many of these software deals were underwritten with higher leverage than the broad market. And as a that you also have more front loaded maturities in the sector, which brings the risks of refinancing if some of this disruption persists. But Vishy, that's a nice segue to you over the past couple of years. You looked at the private credit market in depth and that's where I think the exposure we found is the highest in BDCs, which is the public face of private credit. So in your assessment, what is the risk of software to private credit given all of the headlines that are popping

A (2:28)

up Public ways of private credit Vishwas, that's a great line. BDCs Business dialogue corporations for those who are not familiar, are companies that invest in the debt of small and medium sized companies sourced through non bank channels. BDCs fund themselves through equity and debt issuance. So if you look at the portfolios of BDCs to look at their exposure to software, there's a wide variation across the various BDC portfolios. What makes the assessment of these software risks in BDCs challenging is that many of these companies are private companies without the reporting obligations of public companies. So no earnings reports, no 10Ks or Qs or broadly publicly available financials look at. So in effect these companies need to be re underwritten to evaluate which of these companies would be disrupted from AI and which companies could actually benefit from AI and see their margins expand. So in the context of BDCs, liability spreads are something we are watching closely. BDC liability spreads have widened but we think more needs to happen there. The clearing levels need to wait for the full resolution of the companies that benefit and that get hurt by disruption that is still awaited. So we expect credit spreads of BDCs to remain volatile for some time to come.