PIMCO Says AI Could Trigger Stress Across Private Credit's Software Bets

Artificial intelligence may be creating a new fault line in leveraged finance, with PIMCO warning that the technology could erode the software business models underpinning billions of dollars in private credit and leveraged loan deals.

In its latest "Credit Market Lens" analysis, the asset manager said AI is beginning to challenge assumptions underpinning many software-backed leveraged buyouts and private credit deals.

While higher interest rates and weaker underwriting remain key headwinds, PIMCO said AI adds a new layer of risk that could pressure credit performance even without a broader economic slowdown.

Software has become a cornerstone of both direct lending and broadly syndicated leveraged loans, thanks to recurring revenue, high margins and relatively stable cash flows.

Those characteristics fueled higher leverage and more aggressive deal structures during the post-pandemic credit boom.

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Bankruptcy PIMCO said AI is now undermining that stability by creating uncertainty around pricing power, customer retention and profit margins.

As AI reshapes competition, the financial assumptions supporting many leveraged deals may prove less durable than expected.

Software accounts for a significant share of leveraged-loan and private-credit portfolios.

As a result, earnings pressure could ripple through the broader credit market.

PIMCO added that weaker underwriting during the recent credit cycle—including looser covenants and more permissive financing terms—has left portfolios more vulnerable if software fundamentals deteriorate.

The firm also noted that much of the software loan universe sits at the lower end of the credit spectrum, making it especially susceptible to downgrades if earnings weaken.

Even modest deterioration could push more borrowers into distress, with collateralized loan obligations (CLOs), which hold large portions of leveraged loans, potentially amplifying the impact as lower-rated exposures become more sensitive to price declines, particularly in deals nearing the end of their reinvestment periods. "A wave of software downgrades could therefore create pressure beyond the sector itself – not necessarily through realized defaults, but through weaker marks and reduced structural protection," the report noted.

At the index level, the analysis supports a continued preference for high-yield bonds over leveraged loans.

It also argues that the relative value trade-off between the two markets "cannot be reduced to carry versus duration, since duration risk can be hedged while structural credit deterioration is much harder to offset," the report concluded.

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