Morgan Stanley: Private Credit Defaults Increasingly Hit Software Companies

The private credit market, long considered a safe harbor for investors, has started sending warning signals in exactly the place where investors expected the most stability. According to Morgan Stanley strategists, the rise in defaults is now especially visible in the software sector, one of the largest segments of private lending.

Where defaults are rising

Morgan Stanley points to an uncomfortable concentration of problems: defaults increasingly occur among software companies, even though for many years they were seen as convenient borrowers for private credit funds. The logic was simple. SaaS businesses live on subscriptions, receive revenue regularly, scale relatively easily and do not need the capital spending of industry or logistics. For alternative asset managers, this looked like an almost ideal combination of growth and predictability.

But that structure has now begun to wobble. According to Bloomberg credit reporter Emily Graffeo, new research shows defaults accelerating in private credit and especially in software. This matters not only because of the bankruptcies or missed payments themselves. Software accounts for a sizable share of private lenders' portfolios, so a local problem can quickly turn into a systemic risk for an entire asset class. In private credit this is felt more strongly than in public markets: such deals are less liquid, and deteriorating borrower quality is harder to move off the balance sheet quickly.

Why the model failed

The main reason the market is now discussing is the AI shift inside the software business itself. For ten years, funds financed companies on the thesis of "reliable recurring revenue." If a customer pays every month, the product is embedded in workflows and churn is low, the debt load looks manageable. That thesis still holds for some companies, but no longer for the sector as a whole.

Investors now see that even a sticky subscription does not guarantee protection from technological obsolescence. New AI tools are changing the rules faster than weaker players can adapt. Features that were a separate paid product only yesterday are becoming built-in capabilities of a larger platform. Price pressure is growing, product update cycles are speeding up, and barriers to entry for new competitors are falling. For companies carrying debt this is especially painful: they must retain customers, rewrite their product strategy and service their loan at the same time.

This does not mean all software has suddenly become a bad asset. Rather, the market is ceasing to view it as a homogeneous category. The difference between a platform whose absence would halt a key customer process and a narrow service whose function can be built into a competitor's bundle is now becoming critical not only for equity valuation but for the credit committee. That difference was often lost in averaged credit models; now it moves to the foreground.

What investors will see

For private credit, this is not just a story about one sector. If software, regarded as "defensive," starts to fail, lenders will look harder at old risk-assessment assumptions. This applies especially to deals where growth was estimated too optimistically and revenue resilience was taken almost as a given. The reassessment will affect not only new loans but also existing portfolios, where software's resilience was previously priced in almost automatically.

The next stage will most likely not be a full retreat from software but tighter segmentation within it. Money will stay with companies deeply embedded in customer processes and with clear unit economics, but due diligence will be deeper and slower. The market will look less at general growth promises and more at concrete signs of business durability. First of all, lenders will start examining several things:

• how quickly the company's product can be replaced by a competitor's AI feature;
• what share of revenue comes from truly irreplaceable use cases;
• how quickly the business loses margin if it has to cut prices;
• whether cash flow covers not only growth but also debt service;
• whether management has a realistic plan to rebuild the product for the new competition.

This changes the behavior of both sides. Lenders will likely demand tighter covenants, lower leverage and more conservative multiples. Borrowers will have to prove not only their growth rate but also that their product will not turn into an "AI feature" built into someone else's ecosystem in six months. For late-stage SaaS companies, this may mean more expensive capital and tougher refinancing negotiations, especially for those who counted on replacing old debt with new funding on similar terms.

What this means

The rise in software defaults shows a simple shift: the market is no longer ready to treat subscription revenue as an automatic guarantee of stability. In the AI era, investors are beginning to assess software not as an abstractly reliable sector but as a field of sharp technological repricing, and for private credit this may become one of the main stress tests of 2026.