The leveraged loan market is showing a clear performance gap as worries about software loans increase, Morningstar reported.
The firm created new indices that track leveraged loans without software debt exposure, and found these outperformed indexes that include software by nearly a full percentage point.
"One of the biggest stories this year is the bifurcation in leveraged loans between software loans and the rest of the market," said Elizabeth Templeton, a senior product manager at Morningstar.
Templeton said software credits have taken a hit since February of this year, and the trend is continuing. The company thought it would be interesting to find out what the index looked like without software loans.
The result: For 2026 the rest of the market performed significantly better, and even better without software loans.
Morningstar was also curious about whether the pattern in the U.S. leveraged loan market, where software's negative effect on 2026 performance has been more pronounced and software makes up over twice as much as any other sector, was also present in Europe, Templeton said.
In Europe, software is a large but diversified sector.
For triple-C or even B-minus loans, there might be trouble refinancing.
Kenny Tang, senior director, U.S. credit research at PitchBook, said that with the ongoing negative sentiment around software loans, it's harder to refinance, especially on the distressed side.
"For triple-C or even B-minus loans, there might be trouble refinancing," Tang said. "Even if refinancing is possible, these loans might see higher spreads just because there's less appetite for this type of paper."
Application software loans are facing a maturity wall amounting to roughly $32 billion in 2028 or earlier. . Another $13 billion could come due for cybersecurity, infrastructure, and data software industry loans.
"The negative market sentiment has generally impacted the whole software sector but there are varying degrees of sensitivity to artificial intelligence-disruption as not all software subsectors are equally affected," said Tang, clarifying that it is important to have some discernment in terms of company and by subsector.
The application software subsector is more sensitive to AI-disruption than other subsectors such as cybersecurity and infrastructure and data, Tang said.
Impact on CLOs
CLOs are likely to be affected by the weakness in software, Tang said. Whether in the broadly syndicated market (BSL) or private credit, Tang explained that software loans have struggled across the board.
Since CLOs make up about two-thirds of the BSL market and software loans represent roughly 10 percent of both BSL and CLO portfolios, increased risk in software loans could translate to higher credit risk for CLOs. The effect might not be evenly distributed, but similar concentrations suggest that CLOs will reflect some of the same risks present in the BSL market, Tang said.
However, despite concerns about software exposure, CLOs aren't just a bet on any one sector, said John Kerschner, global head of securitized products and portfolio manager at Janus Henderson. They're diversified portfolios that typically hold hundreds of loans across a wide range of industries, Kershner said.
"While some software companies are facing challenges from changing competitive dynamics and AI-related disruption, others continue to perform quite well," Kerschner stated. "That's why we wouldn't expect weakness in a subset of software loans to translate directly into weakness in CLOs."
Kerschner said diversification and structural protections are significant at the CLO level. Senior tranches, such as triple-A CLOs, are securities with significant credit enhancement and exposure spread across hundreds of underlying borrowers.
Even if software remains a weakness in the loan market, he added, they expect the impact on higher-rated CLO tranches to be relatively limited.
"Concerns around AI disruption or changing business models are more likely to be felt at the individual company level and, potentially, in lower-rated parts of the capital structure before they affect senior CLO tranches," Kerschner stated. "We actually embrace periods of dislocation like what is happening in software since while it has limited impact on overall CLO performance, it does differentiate CLO managers' performance and highlights the value they are providing by managing their loan portfolios."
The performance dispersion helps them calibrate their process and assessment of overall CLO manager selection, he said.
Not all software companies face the same challenges. Dispersion between stronger and weaker issuers is increasing, Kerschner said.
"From our perspective, the greatest risk is concentrated in companies whose business models may be vulnerable to competitive pressures or technological disruption," Kerschner said.
