The stock market has become a hunting ground for future victims of AI, with seemingly daily sell-offs driven by fears that the technology will destroy business models.
At the forefront has been a slump in “software as a service” companies attributed to fears that chatbots will soon be able to replicate what they do. Companies ranging from Salesforce, the customer service software maker, to Palantir, the big data giant, have been caught up in the chaos.
But it is not just software companies – there are lenders hurting too.
When Blue Owl, the private credit behemoth, permanently blocked withdrawals from one of its tech-heavy private credit funds recently, it sent shock waves across the entire sector.
The move to gate the $1.6bn (£1.2bn) fund aimed at retail investors triggered a 10pc fall in its shares and dragged down other private credit providers along with it.
The announcement sparked fears of a broader crisis in private credit, a sector often referred to as shadow banking.
Meanwhile, the Bank of England is racing to understand the risks to the UK. It plans to conduct the world’s first stress test of the shadow banking sector to see how it would cope with a global shock.
But as it prepares for the dummy run, a real-life crisis is already taking hold.
Since the start of the month, private credit providers have been subject to a brutal sell-off. A closely watched index of 44 business development companies (BDCs), vehicles used by private credit players to extend loans, has shed around $5bn across February.
Funds managed by Blue Owl are among the worst affected, though other private credit providers including Sixth Street, Crescent Capital and Stellus Capital have also seen their share prices slide considerably. Barclays estimates that roughly a fifth of all loans held by BDCs have been made to the software industry.
“I think for private credit lenders and BDCs specifically, they tend to gravitate to industries that they believe are growing, that do not have significant capital expenditure needs and are less cyclical than other types of industries,” says Corry Short, an analyst at Barclays.
“Software did really check a lot of those boxes. It fit the underwriting appetite at a time when there was just a decent amount of deal flow.”
UBS has warned that private credit could see default rates surge to as high as 13pc in a worst-case scenario. As much as 35pc of the $1.7tn private credit market is exposed to disruption from AI, it added.
The rout is unlikely to abate either, the bank said, with parts of the credit market only in the “early-to-mid” innings of the sell-off.
Such forecasts matter beyond Manhattan, where Blue Owl and many others are based. Shadow banks are interwoven with regulated banks and pension funds that lend to them, meaning a crisis could quickly spread to the real economy.
It is not yet known how problems in private credit would precisely impact banks and pension funds, which is why the Bank of England is investigating. Because of the paucity of data, the crucial question of whether the sector poses a systemic risk to the UK’s financial stability also remains unresolved.
At the riskier end of the private credit loan market, issuances have fallen by 30pc year on year, according to UBS. Such a fall is often a harbinger of further downward slides in the wider loan market, the bank added.
‘We don’t have red flags’
As the UK has the second-largest private market after the US, there are concerns that ructions across the pond could have an impact in Britain.
Julien Conzano, an analyst at UBS, said an excess of capital and plenty of start-ups wanting to be the next Google led to the sector’s heavy backing of software businesses.
Craig Packer, co-president of Blue Owl, described the firm as “probably the largest lender” to private equity-backed software companies in 2023.
The firm has been less boastful since then. Marc Lipschultz, its co-chief executive, told investors in an earnings call last month that its software lending portfolio was in “pristine” condition.
“We don’t have red flags,” Lipschultz said. “We don’t have yellow flags. We actually have largely green flags.”
“The tech portfolio continues to be the most pristine amongst all of our portfolios.”
The reassurance did little to convince investors. Requests to take money out ultimately contributed to Blue Owl’s decision to limit withdrawals from its funds and wind them down. The private credit provider said it would make episodic payments to shareholders, and announced a plan to sell $1.4bn in assets across three of its funds to return cash to investors.
“There’s always a surprise in a credit cycle,” Jamie Dimon, the chief executive of JP Morgan Chase, warned last week. “The surprise has often been which industry [is impacted most].
“You didn’t expect utilities and phone companies in ’08, ’09, and this time around, it might be software, because of AI.”
‘Is software dead?’
Alastair Unwin, a fund manager at Polar Capital Technology, says: “There is a risk that the software itself is no longer the product; the intelligence it delivers is the product. Companies selling ‘tools for humans’ will lose to companies selling ‘agents that do the work’.
“In the most optimistic scenario, leading software companies successfully invest aggressively in AI capabilities to reinvent their products to address growing competitive threats.
“The best software and information services companies may navigate this period successfully and reinvent themselves, but history suggests the intervening period is usually uncomfortable.”
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Shadow banks can’t say they weren’t warned. Concerns about the future viability of the software sector have been bubbling in the background for quite some time.
Last year, while rivals were leaning ever further into software, Apollo Global Management, the private equity giant, was rapidly cutting its exposure.
Addressing a gathering in Toronto last autumn, John Zito, the firm’s co-chief executive, was among the first to air concerns that AI might be coming for the software industry. He warned that it may be the biggest threat to private credit, rather than tariffs, inflation or higher interest rates.
“The real risk is,” he said, “is software dead?”
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