Private Credit Dominates While AI Threatens Software

In Brief:

Artificial intelligence will trigger the biggest wave of defaults in private credit history as thousands of software companies fail to transform into AI-first businesses, warns Bruce Richards, CEO of Marathon Asset Management. Richards predicts that software sector default rates will triple over the next five to seven years, forcing his $24 billion credit-focused firm to halt all software lending until companies prove they can navigate the AI transition. Speaking at an iConnections panel, Richards argues that while private credit delivers superior risk-adjusted returns in today's higher-rate environment, the AI transformation represents an existential threat to one of the sector's largest exposures. His analysis comes as private credit has emerged as the dominant alternative investment, with top managers earning 12% returns at half the volatility of equity markets.

Big Picture Drivers:

• AI Disruption: Most transformative technology since the internet will create wealth while destroying unprepared companies

• Rate Environment: Higher rates create exceptional lending opportunities with double-digit returns for credit managers

• Credit Dominance: Private credit outperforms hedge funds and private equity on risk-adjusted basis

• Macro Stability: No recession expected despite consumer weakness in lower income segments

Key Topics Covered:

• Federal Reserve Policy: Rates too high relative to 2% inflation, Powell risks waiting too long to cut

• Software Sector Risk: 20-30% of private credit books exposed to companies facing AI transformation threat

• Geopolitical Factors: Tariffs and supply chain disruptions require careful portfolio construction

• Market Convergence: Competition with public markets only affects largest deals above $100 million EBITDA

Key Insights:

• Private credit managers are earning 12% returns with 4-6% volatility while equity markets deliver 7% returns with 16% volatility, making credit the superior risk-adjusted investment in today's environment.

• The Federal Reserve's aggressive 525 basis point rate increase created an ideal lending environment where private credit managers earn "exorbitant rates of return" relative to risk.

• Software companies represent the greatest risk in private credit portfolios because AI will force a "blockbuster video moment" where companies either transform or face near-zero recovery rates for lenders.

• Government deficit spending consumes roughly half of global debt issuance, creating a crowding-out effect that keeps interest rates higher for longer than typical cycles.

• Marathon has implemented a complete halt on software lending until gaining visibility into which companies can successfully transition to AI-first business models.

• The convergence between private and public credit markets only occurs in upper middle market transactions, while true middle market lending maintains wider spreads and stronger covenant protection.

Memorable Quotes:

• "AI will eat software and only that software companies that adapt and have creative destruction for AI will be the ones that survive on the other end" - Bruce Richards, explaining the existential threat facing software companies

• "Private credit all day long" - Bruce Richards, when asked to choose between private equity and private credit investments

• "Making a double-digit return on your private loans when the banks aren't lending is a beautiful thing to be doing" - Bruce Richards, describing the current credit opportunity

• "I slept like a baby in the months of April and May when the markets were just rocking" - Bruce Richards, on his confidence during tariff-induced volatility

• "The default rate for software which has been one-third of that of the overall private credit lending markets will become three times the loss rate" - Bruce Richards, quantifying the coming software sector risk

The Wrap:

Richards' warning represents a fundamental shift in private credit risk assessment, moving beyond traditional economic cycles to focus on technological disruption as the primary threat. His decision to halt software lending entirely signals how seriously Marathon views the AI transformation risk, particularly given that private equity owns approximately 5,000 software companies that could face this transition challenge. The combination of his bullish outlook on private credit's structural advantages and his bearish view on software defaults suggests the industry may need to fundamentally rethink sector allocation strategies as AI adoption accelerates across the economy.