Key takeaways
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- Morgan Stanley expects private credit default rates to climb to 8%, driven largely by stress in software borrowers.
- Software is the biggest concentration risk in many private credit portfolios, with high leverage and weak coverage ratios.
- A heavy maturity wall in 2027 and 2028 could make refinancing harder as fundamentals deteriorate.
- Redemption pressure is already rising, but Morgan Stanley does not yet see the problem as systemic for broader markets.
What Happened?
Morgan Stanley warned that default rates in direct lending are likely to rise to 8% as artificial intelligence increasingly disrupts the software sector. The bank’s analysts said software loans in private credit are especially vulnerable because they carry the highest leverage and lowest coverage ratios among major sectors. The risk is amplified by a maturity wall that is concentrated in the next few years, with 11% of software loans due in 2027 and another 20% in 2028.
The warning comes as investors grow more concerned about how AI could weaken the business models and cash flows of software companies that private equity and private credit firms heavily financed during the last decade.
Why It Matters
This matters because software has been one of the core pillars of private credit growth. Morgan Stanley estimates software makes up about 26% of business development company portfolios and roughly 19% of private credit CLO exposure. If that sector weakens meaningfully, the pressure would hit one of the industry’s largest and most important concentrations.
For investors, the key issue is not just rising defaults, but the combination of high leverage, weaker fundamentals, and looming refinancing needs. That mix can force markdowns, increase redemption requests, and reduce confidence in a market that has relied heavily on retail inflows in recent years. Still, Morgan Stanley’s view is that the risks are significant but not systemic, meaning the pain could be sharp inside private credit without necessarily spilling over into the broader financial system.
What’s Next?
The next big test is how managers handle the approaching maturity wall in software loans and whether they begin to mark assets down more aggressively. Investors should watch for rising default activity, more redemption caps across private credit funds, and any evidence that the buyer base shifts away from retail toward institutional capital.
The broader implication is that private credit may still grow, but likely at a slower pace and with much tighter scrutiny around sector concentration, underwriting quality, and liquidity risk.
