Software Sector Rout Spreading Pain to Debt Markets: Contagion Risks and Credit Market Implications

The software sector’s transformation from market darling to credit risk catalyst represents one of the most significant sector-specific stress events in the leveraged loan market since the post-pandemic repricing. The contagion has expanded rapidly from equity selloffs into leveraged loan and high-yield markets over the preceding weeks, with the leveraged loan market experiencing its first monthly loss since April 2025 [3]. This development signals a fundamental reassessment of software sector credit risk rather than a cyclical correction, driven primarily by mounting concerns about AI disruption threats to traditional software business models.

The sector’s outsize presence in loan portfolios—now comprising 13% of the entire leveraged loan market [5]—means that sector-specific losses carry substantial weight on broad market returns. Software-backed loan prices have fallen to approximately 96 cents on the dollar, the first time since April 2025 [6], indicating meaningful stress in the asset class. The structured product exposure is equally significant, with software comprising roughly 12% of loan indices and 10-15% of most Business Development Company (BDC) portfolios [6]. This concentration creates direct earnings pressure for lenders and investors who have accumulated software exposure across multiple vehicle types.

The private credit ecosystem is experiencing particular strain, with several developments indicating systemic stress. BlackRock TCP fell 17% after announcing a 19% cut to net asset value, driven by exposure to e-commerce aggregators and a home-improvement firm heading toward liquidation [6]. Blue Owl Capital allowed redemptions well above its normal quarterly cap on one fund, signaling liquidity pressure [6]. PIMCO’s president has been notably blunt, stating that investors are underestimating the risks in private credit and that returns are likely to disappoint, with the reasoning centering on a substantial overhang of problem loans made during the 2021-22 period that will take years to fully resolve [6].

: The fundamental driver of software credit stress is the market’s reassessment of how artificial intelligence will impact traditional software business models. Key considerations include lower barriers to entry as AI enables new competitors to emerge with less capital requirements, margin compression as AI-native solutions can be delivered at lower cost points, and growth deceleration as deals underwritten at 15-20× EBITDA in a zero-rate environment now appear expensive as growth rates normalize and equity multiples compress [6]. This represents a structural shift in how investors value software credits rather than a temporary market dislocation.

: Large software loans increasingly lack traditional protective covenants, leaving lenders exposed to adverse developments without traditional investor protection mechanisms [7]. Oaktree Lending’s earnings call highlighted this concern, noting that large-cap software companies increasingly operate without traditional loan covenants. This structural change in lending documentation means that lenders face mark-to-market losses on loan portfolios despite no actual defaults occurring, creating volatility in fund NAVs without corresponding credit event resolution.

: Market volatility has increased across equities, commodities, and digital assets in recent weeks, with market participants attributing this to leveraged investors being forced to rapidly unwind positions [2]. This deleveraging dynamic creates feedback loops that amplify initial stress signals, with alternative asset manager Blue Owl tracking toward its eleventh straight session of declines as of February 5, 2026 [2]. The rotation from growth and technology into value-oriented sectors represents a meaningful shift in capital allocation that had characterized the bull market beginning in October 2022 [2].

: Not all software credits are experiencing equal stress. AI infrastructure plays continue to attract capital while legacy software faces repricing. Companies like CoreWeave rallied approximately 3 points following a $2 billion investment from NVIDIA, while Applied Digital hit fresh highs [6]. Oracle announced a $45-50 billion debt raise for cloud infrastructure—half in debt—suggesting market access remains open for established players with clear AI strategies [6]. This differentiation will likely widen as the market distinguishes between AI-disrupted and AI-enabled software business models.

The software credit stress event presents several interconnected risks for market participants. The 13% software exposure in leveraged loans represents a meaningful concentration risk that could amplify broader market stress if conditions deteriorate further [5]. The sponsor-backed software credits led the selloff, with spreads widening to the third-widest in the index [6], indicating significant risk premium being demanded by lenders. The distressed software loans that swelled by $18 billion in just weeks [4] suggest rapid deterioration in credit quality perceptions that may continue accelerating.

Private credit portfolio marks trail public-market repricing, suggesting further NAV adjustments may be forthcoming within the next three to six months. The 2021-22 vintage loans remain an overhang that will take years to resolve [6], creating persistent headwind for private credit returns. Nine BDC vehicles raised $5.3 billion in investment-grade debt at approximately 200 basis points over benchmarks [6], building war chests ahead of fourth-quarter earnings, which suggests institutional anticipation of continued market stress requiring defensive positioning.

The credit stress also creates potential opportunity windows for well-capitalized investors with longer time horizons. The rotation from CCCs leading rallies to CCCs now suffering the biggest losses within a compressed timeframe [6] demonstrates rapid deterioration in risk appetite that may eventually create entry points for contrarian investors. Investment-grade technology credits with strong balance sheets maintain relative stability, suggesting quality differentiation could reward security selection skills.

AI-adjacent credits continue attracting capital, with NVIDIA’s $2 billion investment in CoreWeave representing confidence in AI infrastructure plays [6]. Companies establishing clear AI strategies may find continued market access despite broader sector stress, creating potential for relative outperformance among software issuers who successfully navigate the transition. The distressed loan prices—trading at approximately 96 cents on the dollar [6]—may represent attractive entry points for investors with appropriate risk tolerance and investment horizons.

The compressed timeline of credit deterioration—swelling from baseline to $18 billion in distressed software loans within weeks [4]—suggests elevated urgency for risk assessment and portfolio positioning. The first monthly loss for leveraged loans since April 2023 [3] marks a meaningful inflection point rather than a minor correction. Market participants should prioritize assessment of software exposure concentration across portfolios, evaluate covenant protections on existing software loan positions, and monitor spread levels for stabilization signals over the coming quarter.

The software sector rout represents a systemic repricing event with implications extending beyond the technology sector into broader credit markets. Software loans now comprise 13% of the leveraged loan market [5], meaning sector-specific losses carry substantial weight on broad market returns. The distressed software loans swelled by $18 billion in a span of just weeks [4], with prices falling to approximately 96 cents on the dollar—the first time since April 2025 [6].

The primary catalyst is investor concern about AI disruption to traditional software business models, including lower barriers to entry, margin compression, and growth deceleration [6]. Covenant-light structures in large software loans have reduced traditional lender protections [7], while 2021-22 vintage loans remain an overhang that will take years to resolve [6]. Private credit funds face potential NAV adjustments as portfolio marks catch up to public-market repricing.

Differentiation is emerging within software credits: AI infrastructure plays continue attracting capital while legacy software faces repricing. Clear AI strategies are becoming table stakes for market access [6]. The stress event underscores the importance of concentration monitoring, covenant review, and quality differentiation in software credit portfolios going forward.