Software, once a defensive haven for credit investors, faces a major threat from AI. AI's ability to standardize data and workflows could disrupt legacy SaaS companies, making the 30% of direct lending portfolios concentrated in software a significant, overlooked risk.

Default rates are not uniform. High-yield bonds are low due to a 2020 "cleansing." Leveraged loans show elevated defaults due to higher rates. Private credit defaults are masked but may be as high as 6%, indicated by "bad PIK" amendments, suggesting hidden stress.

Unlike prior tech revolutions funded mainly by equity, the AI infrastructure build-out is increasingly reliant on debt. This blurs the line between speculative growth capital (equity) and financing for predictable cash flows (debt), magnifying potential losses and increasing systemic failure risk if the AI boom falters.

The rapid accumulation of hundreds of billions in debt to finance AI data centers poses a systemic threat, not just a risk to individual companies. A drop in GPU rental prices could trigger mass defaults as assets fail to service their loans, risking a contagion effect similar to the 2008 financial crisis.

A new risk is entering the AI capital stack: leverage. Entities are being created with high-debt financing (80% debt, 20% equity), creating 'leverage upon leverage.' This structure, combined with circular investments between major players, echoes the telecom bust of the late 90s and requires close monitoring.

According to Manny Roman, AI will empower large companies to build their own software solutions in-house, replacing expensive third-party contracts. This poses a significant threat to the predictable revenue streams of many enterprise software companies, potentially upending private equity investments that rely on those cash flows.

Private credit funds have taken massive market share by heavily lending to SaaS companies. This concentration, often 30-40% of public BDC portfolios, now poses a significant, underappreciated risk as AI threatens to disintermediate the cash flows of these legacy software businesses.

Unlike past recessions where defaults spike and then recede, the current high-rate environment will keep financially weak 'zombie' companies struggling for longer. This leads to a sustained, elevated default rate rather than a sharp, temporary peak, as these firms lack the cash flow to grow or refinance.

Once considered safe due to low CapEx and recurring revenue models, the technology sector now shows significant credit stress. Investors allowed higher leverage on these companies, but the sharp rise in interest rates in 2022 exposed this vulnerability, placing tech alongside historically troubled sectors like media and retail.