By Bill Alpert

AI's shadow has shrunk the S&P Software Index 22% this year. But the price of software loans has only slipped about 3%.

That shallow move in loans makes the credit strategists at Morgan Stanley wary, they say in a Monday note on credit market exposure to software. The high-yield bond market is the best insulated, while business development companies, or BDCs, are the most exposed.

"We don't expect an immediate rise in defaults," the analysts wrote, "but rather price declines that are likely to get worse and persist for a while."

Software is a significant piece of private-credit portfolios, so meaningful stress in that segment could spill over into the broader loan market. That's what happened about 10 years ago, the analysts say, when a fall in oil prices caused roughly 25% of energy borrowers to default, and the spreads on non-energy high-yield bonds roughly doubled.

In the worst-case software scenario, the Morgan Stanley analysts estimate that cumulative defaults might hit 6% to 9% of the leveraged loan market, and 8% to 12% of BDC portfolios.

The report estimates that about 30% of all BDC portfolios are loans to software and computer services firms. Among the highest concentrations the analysts found in September 2025 reports were Blue Owl Technology Finance Corp., the Saratoga Investment Corp., the Goldman Sachs BDC, and the Sixth Street Specialty Lending BDC.

Software worries have already caused a steep selloff in the stocks of publicly traded BDCs. But the Morgan Stanley analysts note that September data showed relatively few BDC software loans that weren't accruing interest. Most loans were still carried at close to their original value.

Looking ahead, the analysts worry that nonaccruals and markdowns will become more prominent at BDCs.

The Covid pandemic led to a surge in software buyouts, and much of the leverage for those deals came from private-credit funds. Some of the steepest price drops tallied by Morgan Stanley this year include the 29% haircut on loans to Veracode, a security software firm majority owned by TA Associates, and the 20% price drop for Qlik Technologies, mainly owned by Thoma Bravo.

There aren't a lot of high-yield bonds issued by software or tech firms, the report says. The busiest issuers have actually been AI-enablers, like the data center operator Coreweave.

Widening spreads on the quoted price of a bond can signal market wariness. Among the names where spreads have widened this year are the Rackspace Technology 3.5% bond due May 2028 and the LogMeIn 5.5% bond due May 2028.

A more constructive scenario for software's lenders would be a renewed merger-and-acquisition cycle, in which private equity's portfolio companies find new buyers.

But the timing and scale of an M&A revival can't be quantified, say Morgan Stanley's analysts, since borrowing costs for a buyer are higher now than they were when private equity acquired many of these companies in the Covid era.

Write to Bill Alpert at william.alpert@barrons.com

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February 10, 2026 16:50 ET (21:50 GMT)

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