Software debt plummets: AI disruption concerns trigger sell-off in credit markets

Software and Services Sector Leads Market Decline

The U.S. leveraged loan market suffered a heavy blow in February, recording its largest monthly decline in over three years. According to the Bloomberg U.S. Leveraged Loan Index, the average price dropped 1.34% in February. This marks the most turbulent period for this asset class since September 2022, when aggressive rate hikes first raised concerns about a recession.

The main catalyst for the sell-off appears to be growing anxiety over artificial intelligence. Investors are increasingly worried that AI-driven disruption could destroy traditional business models. This sentiment has hit the software and services sector particularly hard, as these companies are seen as being at the forefront of technological replacement.

As prices decline, billions of dollars of debt have officially entered the “distressed” zone. For companies with below-investment-grade credit ratings, this shift is more than just a price drop; it creates significant hurdles for future financing. Debt trading at these levels often indicates an increased risk that companies will struggle to refinance when debt matures.

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Liquidity Tightening, New Loan Issuance Plummets

The chain reaction of uncertainty related to AI is also clearly visible in the primary market. U.S. new loan issuance has plummeted to its lowest level since May. This indicates that both lenders and borrowers are pulling back, trying to digest the potential long-term impact of AI on corporate creditworthiness.

Liquidity tightening has been exacerbated by large outflows from this sector. Recent data shows that U.S. loan funds are experiencing the highest redemption rates since April last year. As market buyers decrease, existing holders seek to exit, putting ongoing downward pressure on prices throughout February.

The current environment represents a fundamental shift in how credit analysts view technology risks. While interest rates used to be the main concern for leveraged loan investors, “AI substitution risk” has now risen to a top priority. As the market searches for a bottom, the gap between AI “winners” and those viewed as “traditional” software providers continues to widen.

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