December 5, 2023 Apollo Global Management sign in New York.
Jin Moon | Bloomberg | Getty Images
Personal loan markets are facing new uncertainty as AI-driven tools begin to put pressure on software companies, a key borrower group for private lenders.
The software industry came under renewed pressure last week after artificial intelligence firm Anthropic unveiled new AI tools, sparking a selloff in the software data provider’s stock.
AI tools developed by Anthropic are designed to handle complex professional tasks that many software companies currently pay for, raising new concerns that AI could undermine traditional software business models.
Shares of asset managers with major private lending franchises fell this week as investors worried about how AI could change borrowers’ business models, pressure cash flows and ultimately raise default risks.
Ares Management fell more than 12% last week, while Blue owl capital lost more than 8%. KKR decreased by almost 10%. TPG lost about 7%. Apollo Global and BlackRock decreased by more than 1% and 5%, respectively. In comparison, S&P 500 decreased by about 0.1%, and technologically heavy Nasdaq decreased by 1.8%.
The moves add to growing concerns around the personal loan market, which is now set to hit the AI-driven disruption software sector, which market watchers say is heavily exposed to acquisitions financed by opaque, illiquid loans.
Personal loan loans to many software companies. If they start going south, the portfolio will have problems.
Geoffrey Hook
Johns Hopkins Carey Business School
“Enterprise software companies have been a favorable sector for private lenders since 2020,” PitchBook wrote in a post-recession report last week, noting that most of the largest consolidated loans (two or more loans), a favorite structure of the personal loan market, were owned by software and technology companies.
Software accounts for a significant share of loans to US business development companies, accounting for about 17% of BDC investments by number of deals, second only to commercial services, according to PitchBook data.
If AI adoption is faster than borrowers can adapt, this impact could be costly. UBS Group warned that default rates on US personal loans could rise to 13% in an aggressive default scenario, significantly higher than the expected stress for leveraged loans and high-yield bonds, which UBS estimates could be around 8% and 4%, respectively.
“Personal loan loans to a lot of software companies,” said Jeffrey C. Hook, senior lecturer in finance at Johns Hopkins Carey Business School. “If they start going south, there will be problems with the portfolio.”
Huk, however, said personal credit problems predate recent AI issues, focusing on liquidity and credit extension issues. “Many private equity funds are having trouble liquidating their loans,” he said, adding that recent developments have added another layer to a sector already under pressure.
This new notifications panel comes at the back The latest concerns in a $3 trillion industry increased leverage, opaque valuations and the risk that isolated problems become systemic problems JPMorgan’s Jamie Dimon warned of personal loan “cockroaches” late last year, warning that the stress of one borrower could mean hidden problems.
“AI disruption may be a credit risk to individual lenders for some software and service sector borrowers and not for others, depending on which of them are behind the AI curve and which are ahead of it,” said Kenny Tang, head of U.S. credit research at PitchBook LCD.
Software and service companies account for the largest share of payment in kind (PIK), Tang added. loans, which refer to agreements where borrowers can defer cash interest payments. While PIK structures are often used to give fast-growing companies time to build revenue and cash flow, they become a risk if the borrower’s finances weaken. In that case, deferred interest can quickly become a credit problem, he said.
Mark Zandi, chief economist at Moody Analytics, noted that while it is difficult to fully assess the sector’s risks given its transparency, rapid growth in AI-related borrowing, increased leverage and a lack of transparency are significant “yellow flags.”
“Of course, there will be significant credit problems, and while the private lending industry can absorb any losses well at the moment, that may not be the case a year from now if current credit growth continues.”