Private Credit Insights: Cut the SaaS

Justin Stach - Managing Director, Head of Private Credit

Key Takeaways

• Private credit’s exposure to software companies is estimated at $226 billion; it also the most levered sector in all of core and upper middle market direct lending.
• While often labeled “senior secured,” these software loans are likely to have very low recovery rates in times of trouble (or transformational tech sector change) due to their lack of tangible collateral.
• The distress already visible in software leveraged loans is likely to show up in high yield private credit portfolios too, although the high preponderance of software private placements with payment-in-kind (PIK) toggles may allow some managers to delay formal acknowledgement of loan issues.
• Voya is structurally insulated from software credit risk, with 0% of its primarily project finance-based high yield private credit portfolio in software loans, and only 2% of its investment grade private credit portfolio in technology of any sort.

The software sector is high yield private credit’s largest borrower by debt outstanding. As some software companies grapple with the specter of AI-driven obsolescence and slowing growth, it’s worth taking a closer look at your direct lending investments.

Going soft
Recent headlines have raised concerns about AI’s impact on software companies, prompting many private credit managers to revisit their exposure to these vulnerable segments. Should you be worried about software loans in private credit? Yes, and we’ll get into why in a moment.

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A note about risk

All investing involves risks of fluctuating prices and uncertainties of rates of return and yield. All security transactions involve substantial risk of loss.

Private credit: Foreign investing does pose special risks, including currency fluctuation, economic, and political risks not found in investments that are solely domestic. As interest rates rise, bond prices may fall, reducing the value of the share price. Debt securities with longer durations tend to be more sensitive to interest rate changes. High yield securities, or “junk bonds,” are rated lower than investment grade bonds because there is a greater possibility that the issuer may be unable to make interest and principal payments on those securities. Other risks of private credit include, but are not limited to: credit risks, other investment companies risks, price volatility risks, inability to sell securities risks, and securities lending risks.

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Index definition: The Cliffwater Direct Lending Index is an asset-weighted index of approximately 17,300 directly originated middle market loans totaling $425 billion. it is calculated quarterly and seeks to measure the unlevered, gross of fees performance of U.S. middle market corporate loans, as represented by the underlying assets of including both exchange-traded and unlisted Business Development Companies, subject to certain eligibility criteria.

Past performance does not guarantee future results. This market insight has been prepared by Voya Investment Management for informational purposes. Nothing contained herein should be construed as (i) an offer to sell or solicitation of an offer to buy any security or (ii) a recommendation as to the advisability of investing in, purchasing, or selling any security. Any opinions expressed herein reflect our judgment and are subject to change. Certain statements contained herein may represent future expectations or other forward-looking statements that are based on management’s current views and assumptions and involve known and unknown risks and uncertainties that could cause actual results, performance, or events to differ materially from those expressed or implied in such statements. Actual results, performance, or events may differ materially from those in such statements due to, without limitation, (1) general economic conditions, (2) performance of financial markets, (3) interest rate levels, (4) increasing levels of loan defaults, (5) changes in laws and regulations, and (6) changes in the policies of governments and/or regulatory authorities. The opinions, views, and information expressed in this commentary regarding holdings are subject to change without notice. The information provided regarding holdings is not a recommendation to buy or sell any security. Fund holdings are fluid and are subject to daily change based on market conditions and other factors.

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