"AI disrupts everything" severely impacts the software outlook! Morgan Stanley sounds the alarm for direct lending, private credit default rate may rise to 8%

Recently, Wall Street financial giant Morgan Stanley stated that the rapid development of artificial intelligence technology is continuously disrupting the global software industry's profit growth prospects, and the default rate in the direct lending sector will quickly rise to 8%. Morgan Stanley stated that the software industry's credit fundamentals in global major industries are facing significant challenges with the highest leverage and lowest coverage ratio. If the pessimistic narrative logic of "AI disrupts everything" continues to dominate market risk pricing, the overall trend of private credit default rates can be said to be skewed towards the upside. Morgan Stanley's market analysts team, including Joyce Jiang, stated in a report on Monday that although artificial intelligence disruption has not yet significantly impacted the fundamentals of private credit in a "substantive and precise way," the high leverage of the software industry and looming maturity wall may significantly push up the direct lending default rate to levels not seen since the COVID-19 pandemic. Direct lending is the most core and common sub-sector in private credit. The analysts wrote, "The credit fundamentals of the software industry loans are facing severe challenges, with the highest leverage and lowest coverage ratio among major industries globally." They added that although default situations in the public and private lending markets have eased somewhat, with the gradual spread of AI disruption globally, default rates will only continue to rise. In recent months, the global credit market has faced severe sell-offs and redemption pressures as investors actively evaluate how artificial intelligence will disrupt revenue sources for SaaS companies and software companies broadly. Over the past decade, alternative asset management giants, including Blue Owl, have poured into software companies, attracted by their predictable profit curves and higher profit margins. With Morgan Stanley raising its expected direct loan default rate to 8%, and earlier UBS predicting that AI disruption will more prominently reflect on low-quality, high-refinancing-demand credit assets by 2026 to early 2027, the private credit default rates with labels such as "high software industry exposure, high leverage, and high refinancing pressure" may rise significantly in the near future. In other words, if the pessimistic narrative of "AI disrupts everything" continues to dominate risk pricing, the default rate trend indeed remains upward, but more like a "structural rise in sectors disrupted by AI" rather than "full-on market meltdown in private credit." Cutting-edge AI technologies are truly impacting not all software companies, but those that have easily consumable features that can be engulfed by native model capabilities, weak moats, heavy implementation and customization requirements, and where customers can partially reconstruct functions with AI on their own. For these borrowers, the issue is not the valuation decline itself, but the sustainability of profit growth, pricing power, and renewal capability being questioned once growth assumptions are revised downward, the credit structures built on high EBITDA multiples and high leverage will quickly become fragile. A study by Fitch Solutions also clearly points out that the most vulnerable software companies are often those that heavily rely on implementation, customization, and products that can easily be replaced by in-house AI development. Therefore, private credit default rates may continue to rise, with the increase being highly concentrated in software direct lending and other areas where business models are directly compressed by AI, with the most dangerous scenario being the combination of "AI disrupts everything" disruption, low ratings, and maturity walls. Furthermore, the ultimate market pricing may not simply be "software across the board loses," the real AI favor may be concentrated in two main themes: the first category is AI deployment and governance infrastructure, which includes platform-type integrated service providers that can help companies actually run AI, such as cloud and model platforms, data governance, identity permissions, audit/security, observability, workflow orchestration, etc.; the second category is the current globally hardest logic market - AI data center computing power and power chain. The narrative of "AI disrupts everything" has swept the global stock market, particularly devastating software stocks. The pessimistic tone of "AI disrupts everything" since February is mainly due to the growing concern in the market about AI agent workflows like Claude and OpenClaw (previously known as Clawdbot, Moltbot) exploding and spreading like viruses, potentially weakening the entire revenue model based on SaaS subscription revenue model for software empires, resulting in a rare sell-off. This sell-off quickly spread to other industries such as insurance, real estate, truck transportation, and any other industry that appears to have a subscription revenue model or labor-intensive business model - the market believes these industries will be completely disrupted by AI. Not only in the US stock market, the software sector in global stock markets has continued to suffer from the pessimism of "AI disrupts everything" since February, despite the surge in stock buybacks in the US software sector, investors are not buying it because the market is genuinely concerned about whether long-term fundamentals and business models will be completely reshaped by AI. Since last fall, investors have been selling off software stocks, and the scale of this selling has intensified since the "Anthropic storm" in February. Due to concerns that the development trajectory of artificial intelligence (AI) will significantly disrupt the competitive landscape of this lightly capitalized sector with already high valuations, the S&P 500 software index has dropped by about 30% since late October. The "Anthropic storm" that devastated software stocks is still fermenting in global stock markets, and this selling pressure has accelerated to wealth consulting and management, as well as real estate consulting and any other traditional industries that appear to be completely disrupted by AI. The pessimistic market expectations of "AI disrupts everything" have hit various industry sectors like a domino effect, with software, SaaS, PE, insurance, traditional investment banks, wealth management, real estate, property management, and even logistics sectors all experiencing significant declines, with investors rapidly selling those deemed potential "losers." With innovative AI intelligent agents focusing on agent workflows being repeatedly launched, they may disrupt one traditional industry after another and suppress pricing power in the wider economy. Since the beginning of this year, concerns about the "AI super tsunami potentially compressing enterprise profits, disrupting employment, and bringing deflationary impacts" have quickly spread to multiple traditional economic sectors such as software, private credit, real estate services, and insurance. The core factor driving the recent sharp decline in software stocks and the successive declines in various sectors is the pessimistic narrative of "AI disrupts everything." This pessimistic narrative has swept through global financial markets since February. The rising momentum of this narrative coincides with the launch of a series of AI tools/agent AI intelligent body collaboration platforms by Anthropic, sparking a widespread sell-off in the SaaS subscription software sector and the overall software sector in the stock market. The "Anthropic storm" that has caused panic among global software stock investors strictly speaking began earlier in February when Anthropic released a heavy legal plug-in for its Claude Cowork, a quickly popular agent AI intelligent body globally. This tool, which enables AI automation of contract review with extremely low technical thresholds, caused the market capitalization of companies like Thomson Reuters and LexisNexis parent company RELX to evaporate by billions of dollars. The selling pressure led by the "Anthropic AI storm" has continued to intensify since late February to March. Recently, Anthropic launched Claude Code Security - an AI-driven network security vulnerability scanner. This tool caused cybersecurity companies including CrowdStrike, Cloudflare, and Okta to plunge by 8% to 10% in a single trading day. Subsequently, after Anthropic stated that its Claude Code tool could help enterprises achieve low-threshold automation processes for traditional programming languages running on IBM systems under AI intelligent body driving, US veteran tech giant IBM suffered its most severe single-day stock price decline in over 25 years. Is private credit risk similar to that on the eve of 2008? Morgan Stanley stated that the software sector is the largest industry sector in Business Development Companies' (BDC) overall investment portfolios, with a related exposure of about 26%. The Morgan Stanley analyst team stated that the exposure of private credit collateralized loan obligations that securitize middle-market loans in the software industry is approximately 19%, with many high-risk loans maturing in the near future. These strategists cited PitchBook statistics to indicate that the software industry loans in direct lending have a "very high degree of front-loading" of maturities, with 11% expiring in 2027, followed by another 20% expiring in 2028. The anxiety surrounding this industry has significantly driven up redemption requests for private credit funds, and fund managers are debating on how to appropriately respond to all investors wishing to withdraw funds. Just last week, after investors' redemption requests far exceeded standard quarterly thresholds, both Morgan Stanley and Cliffwater LLC set withdrawal/asset redemption limits for their multi-billion-dollar private debt funds. It should be noted that while some market observers compare the current crisis in the private credit market to the signs and atmospheres of the subprime crisis on the eve of the 2008 financial crisis, analysts from Morgan Stanley generally believe that although the wider risk spillover potential in the private credit sector is significant, these risks are not systematically significant, and the current market threats to the wider market are very limited. As of the third quarter of last year, the assets held by Business Development Companies allowing retail/independent investors to access private credit investments amounted to $530 billion. This has indeed sparked strong concerns in the market: inadequate liquidity in private credit may harm less experienced investors and weaken one of the significant sources of growth in these markets in recent years. The analyst team at Morgan Stanley pointed out, "The significant slowdown in the demand for private credit by independent investors may shift the composition of the buyer base more towards institutional investors and suppress the growth trend in the size of the private credit market in the future."