A prominent investment executive is warning that turmoil in the software sector could trigger widespread contagion across the private credit market, raising concerns about financial stability. Victor Khosla, founder of Strategic Value Partners and manager of over $20 billion in assets, cautioned that mounting pressure on software companies poses a significant risk to the broader private credit industry during a recent Bloomberg interview.
The warning comes amid growing scrutiny of the private credit sector following Blue Owl’s recent decision to permanently halt withdrawals from one of its funds. This move has drawn comparisons to the fund freezes that preceded the last financial crisis, intensifying concerns about vulnerabilities in this rapidly growing segment of finance.
Software Sector Dominates Private Credit Exposure
According to Bloomberg analysis, software accounts for approximately 40% of all private equity-backed loans outstanding, making it the single largest sector exposure in the private credit market. This concentration creates a potential vulnerability, as stress in one industry could rapidly spread throughout the entire lending ecosystem.
Khosla emphasized the magnitude of this risk by referencing the mid-2010s energy crisis as a comparable scenario. When energy prices collapsed during that period, yields on riskier private debt soared as investors repriced credit risk across multiple sectors.
AI Disruption Could Drive Defaults Higher
The threat to software companies has intensified due to concerns about artificial intelligence disruption. A recent UBS report estimated that private credit defaults could surge as high as 15% if AI transformation proves more rapid and aggressive than currently anticipated, according to Khosla’s interview.
Additionally, the software sector has already experienced significant volatility, with mounting pressure from technological changes and market uncertainties. This instability occurs at a particularly vulnerable moment for private credit markets, which are showing signs of stress through multiple indicators.
Private Credit Market Shows Signs of Strain
Yields on private credit have risen substantially, signaling that investors are demanding higher returns to compensate for increased risks. The effective yield of the ICE Bank of America US High Yield Index currently hovers around 6.5%, representing an increase of approximately 200 basis points over the past five years.
Meanwhile, default rates in the private credit space have climbed higher. According to Fitch Ratings, the private credit default rate reached 5.8% at the end of January, marking a notable increase from previous periods.
Contagion Risk Warnings Intensify
“I do think, though, software is a big stick. You know, the credit market has had all these sticks being dropped on it, and one day, it’ll really buckle,” Khosla said in the interview. He later added a direct warning: “So the contagion risk in credit — yeah, worry about it.”
However, Khosla suggested the deterioration may not happen immediately. He speculated that credit spreads could widen over a three- to six-month period, describing the situation as “underneath the surface, it is really wobbly.”
In contrast to surface-level market stability, Khosla characterized the current environment as presenting “a fat tail risk now,” indicating the potential for extreme outcomes that may appear unlikely but could have devastating consequences if they materialize.
Market participants will be watching closely for further signs of stress in both the software sector and broader private credit markets over the coming months. The timing and severity of any potential contagion remain uncertain, though industry observers acknowledge the risks are mounting as multiple pressure points converge simultaneously.
