A debt maturity wall is approaching software companies that specialize in artificial intelligence (AI), and borrowers that are facing defaults as their products risk obsolescence are selling their debt at a pace that could significantly impact collateralized loan obligations (CLOs).
There continues to remain pressure on the 2026-2027 maturity loans within software.
That potential impact could lead them to increase their use of liability management exercises (LMEs).
"In particular, there is the risk of a self-fulfilling prophecy for software [companies] where CLO managers may be reluctant to participate in some refis due to AI obsolescence risk," pushing some issuers to default that could otherwise stay afloat, said
The bank pointed specifically to recent Moody's Ratings downgrades "on the back of increased refi risks" as maturities approach for Planview Parent's $1.3 billion in term loans, which includes $870 million exposure in U.S. CLOs, and Sophos' $2.2 billion in terms loans.
"There continues to remain pressure on the 2026-2027 maturity loans within software," the bank said.
Revisiting business models
Software companies' challenges, as AI forces many to revisit their business models, are particularly relevant to CLOs, which invest in the leveraged loan market. PitchBook estimates that the software sector represents $250 billion, or about 16%, of the $1.5 billion broadly syndicated loan (BSL) market.
As the maturity wall approaches, 29% of that debt–or 50 transactions amounting to $73 billion–is coming due over the next three years. Forty of those facilities are maturing in 2028, and within this group 20 loans are rated B- and 11 are in the 'CCC' category.
Overall, more than half of the sector, 52%, is rated single B- or lower, said Kenny Tang, head of credit research at PitchBook, and two thirds of those in the 'CCC' bucket are trading below 80.
"Credit risk is higher now, which means that over and above the maturity wall, there's a likelihood that their capital structures will need to be addressed sooner than when the wall hits," Tang said.
Investors in broadly syndicated loans (BSL) are already showing concern. As of March 20, returns for the Morningstar LSTA U.S. Leveraged Loan Index's software segment were down 4.09% year to date, and the IT services sub-sector down 1.7%.
Obsolescence risk could put some sponsors in a bind, especially those who bought these companies at high multiples.
The impact of AI on software companies' business models is still playing out, but the efficiencies generated by AI tools are likely to pressure revenues further. Software companies charging customers on a per screen basis, for example, are likely to see those screens reduced. The sector may have to transition to a less profitable use-based model. Such concerns have weighed down the sector overall, increasing credit risk, pressuring valuations, and potentially hampering debt refinancing efforts.
"Obsolescence risk could put some sponsors in a bind, especially those who bought these companies at high multiples, before the interest-rate hikes starting in March 2022," Tang said.
Another potential source of credit risk to software companies is an escalation in the U.S.-Israel war on Iran, especially if it increases oil and gas price volatility and ultimately inflation, say industry participants. The key is to watch for a general expediting of distress that could lead to an increase in defaults for the software sector.
"That means there's a higher propensity for LMEs to take place in this sector, as the preferred alternative for meeting financing or restructuring needs," Tang said.
