Deutsche Bank warns: the widespread use of AI and high interest rates are squeezing the software industry, making it the biggest hidden risk in the speculative credit market.

Deutsche Bank analysts warned that the software and technology industry is posing an unprecedented concentration risk in the speculative-grade credit market. The analyst team led by Steve Caprio pointed out in a report on Monday that the software and technology industries have debt sizes of $597 billion and $681 billion, accounting for approximately 14% and 16% of the speculative-grade credit market, respectively. Speculative-grade debt includes high-yield bonds, leveraged loans, and U.S. private credit. The analysts stated, "If default rates in the software industry rise, this large stock of debt could drag down overall market sentiment, with potential impacts comparable to the 2016 energy industry crisis." They added that unlike in 2016, the pressure in this round may first appear in private credit, business development companies (BDCs), and leveraged loans, with high-yield markets subsequently feeling the pressure. At the same time, the rapid spread of AI tools may further suppress the valuation multiples and revenues of Software as a Service (SaaS) companies; and the hawkish stance of the Federal Reserve since 2022 has put pressure on corporate cash flows. Data from Deutsche Bank shows that software-based physical payment loans account for 11.3% of BDC investment portfolios, which is more than 2.5 percentage points higher than the already high index average level of 8.7%. These types of loans typically allow borrowers to pay interest with new debt instead of cash. "The current reality is very different from when these companies were initially financed," the analysts wrote. "The value creation model of SaaS has not matured enough to withstand the impact of the rapid proliferation of AI tools."