US private credit faces potentially higher defaults as software exposure weighs

April 2 (Reuters) - The U.S. private credit industry is staring at a period of higher borrower defaults, several brokerages warned, exposing cracks in what had become one of Wall Street's favorite trades in recent years.

While the recent stress in the industry is unlikely to trigger a systemic crisis, analysts expect growth to moderate as AI disrupts software companies, which account for a major chunk of private credit portfolios.

The latest hit to the industry came after Blue Owl OWL.N capped the amount investors can withdraw from two of its retail-focused funds, dragging its shares down 8.6% to a record low.

Other alternative asset managers also fell, with Apollo Global APO.N, Blackstone BX.N and Ares Management ARES.N dropping 4.8%, 3.7% and 4.4%, respectively.

KKR KKR.N slipped 2.2%, while Carlyle Group CG.O lost 3.9%.

SOFTWARE EXPOSURE COULD INTRODUCE RISKS

Private credit, long marketed as a less volatile alternative to publicly traded bonds, grew rapidly since banks retreated from riskier corporate lending after the global financial crisis.

Typically, private credit firms turn to wealthy individuals and institutions for capital, offering semi-liquid funds that promise periodic redemptions while investing in harder-to-sell assets such as buyout stakes and direct loans.

Strong demand for diversification in recent years also pushed fund managers to tap retail investors.

The industry is a key source of capital for small and middle-market companies deemed too risky for traditional lenders.

According to Morgan Stanley, private credit accounted for about 30% of the U.S. leveraged finance market in 2025, up from 13% a decade earlier.

However, concerns about the quality of credit began to emerge in the last few months, triggered by the bankruptcy of auto-parts supplier First Brands.

A drop in valuations of software companies, driven by fears of AI disruption, has also exposed vulnerabilities stemming from the industry's concentration in private credit portfolios.

"Many private credit funds have become very concentrated in a handful of sectors, in particular software. As this risk (of software companies going obsolete) increases, so too will the probability of default," Barclays analysts wrote.

Similarly, Morgan Stanley expects annual private credit defaults of 8% between the second half of 2026 and the first half of next year, led by stress in software companies.

SYSTEMIC RISK OR EPISODIC STRESS?

The wave of curbs on redemptions could heighten scrutiny of similar vehicles and bring questions about valuation, transparency and liquidity risk to the fore.

Some have also flagged the risk of broader systemic stress, though Federal Reserve Chair Jerome Powell said earlier this week that the central bank has not seen anything that threatens the financial system as a whole.

"Systemic risks remain low, banks are well insulated, and institutional investor demand is likely to be stable," Morgan Stanley analysts wrote.

Still, the hit to valuations could linger. Morningstar said that most traditional and alternative asset managers it tracks are trading below their fair value, with some at discounts as high as 15%.