Bruce Richards, Chairman and CEO of Marathon Asset Management, warns that highly leveraged software companies in the direct lending business could experience a 15% default rate in 2027 and 2028. This potential crisis is attributed to several factors, including significant technological changes, the rise of AI, and an excessive amount of capital that has flooded the sector, leading to high leverage.
Richards highlighted that direct lending in software companies often involves leverage as high as 20 times, significantly more than the 10 times leverage seen in the syndicated loan market. He noted that capital is now drying up, and 23% of the direct lending business is exposed to software, an industry that represents only a small fraction (7%) of publicly listed companies and 3% of the overall economy.
The expert compared the current situation in software to the oil and gas industry crisis in 2016-2018, where a 15% default rate was observed. While he believes the broader economy is diverse enough to absorb these defaults without significant disruption, he advises lenders to be very conservative, suggesting a leverage of about three times, rather than ten, and demanding higher compensation for the increased risk. He also pointed out that many software companies are unable to generate sufficient free cash flow to reposition for AI, exacerbating their precarious position.
