Debt Investors Reduce Exposure to Software Companies Amid Sector-Wide Pain

Software Industry Pain Persists Amid AI Disruption

Investors are selling software loans in debt vehicles at a discount, a sign of ongoing pain in the software industry. According to three CLO managers and several credit industry analysts, managers of collateralized loan obligations (CLOs) are exploring ways to reduce their exposure to software due to concerns about rating downgrades on junk bonds and potential defaults.

The trend shows how the pain in private credit and software is still working through the system after the software rout in January and February, which was largely triggered by the release of Anthropic's latest AI tools. Jim Egan, co-head of securitized products research at Morgan Stanley, notes that there is more selling of software loans by CLO managers than buying at present, with elevated exposure to software within broadly syndicated loans (BSLs).

CLOs, which buy up small chunks of numerous individual leveraged loans, have capitalized on the credit boom and bought up loans that backed hundreds of software buyouts in the height of a dealmaking boom during and after the pandemic. According to JPMorgan analysts, around $40 billion to $150 billion of U.S. CLO holdings fall within sectors most associated with AI risk.

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The software and services sector accounts for about 15% of the collateral in currently outstanding syndicated CLO deals in the U.S., with software alone making up roughly 12% of CLO holdings, making it the single-largest subsector by concentration. Software exposure in direct lending is estimated to be about 19%.

Spreads on CLOs have widened over the past few weeks as fears of a meltdown in the $1.8 trillion private credit industry have spooked investors. Some CLO managers are reducing exposure to software, particularly where positions were overweight or ahead of refinancing activity.

A mix of investment-grade notes and high-yield leveraged loans of some software makers, including Intuit, Dayforce, and Citrix, were sold between a range of 89 cents and 98 cents on the dollar in late February and earlier in March, according to data compiled by the Trade Reporting and Compliance Engine (TRACE).

While spreads across the software industry have widened, the spread on Intuit's investment-grade bond that matures in 2033 is largely in line with the level at which it was issued in 2023.

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