US software leveraged loans and CLO credit risk Report Interpretation

Overview

This US corporate-credit and CLO strategy report examines whether improved software-loan refinancing activity has eased the sector's AI-related credit stress. Morgan Stanley concludes that the near-term setup has improved for stronger borrowers, but that refinancing has mostly extended maturities rather than repaired balance sheets or resolved longer-term business-model risks.

Core views

Morgan Stanley argues that software credit markets have moved from a broad AI-driven selloff to highly differentiated, issuer-specific pricing. Software loans recovered 3 points from June lows and trade around 90 points, but still underperform the broader market. About 50% of software names had fallen more than 5 points in the first quarter, while the later selloff showed much wider dispersion: investors are now distinguishing among business-model resilience, AI disruption risk and underlying credit fundamentals. Computer Software and Applications Software have recovered only 20-25% of their year-to-date drawdowns, whereas Enterprise Software rose 3.6 points since July and Property/Casualty Insurance-related names have held up better because they are viewed as less exposed to AI adoption dynamics. Refinancing activity has improved liquidity for selected borrowers. Since April, Morgan Stanley tracked seven refinancing or amend-to-extend transactions and five defaults, including distressed exchanges, among software and adjacent issuers with near-term maturities. This activity, along with paydowns and discount-capture transactions, reduced pre-2028 maturities to about $50 billion from about $75 billion at year-end 2025. In BSL, 2027 maturities fell to about $5 billion, or 2% of the cohort, from about $16 billion, or 6%, at the start of the year; 2028 maturities fell to $48 billion from $60 billion. The report views this as evidence that funding is available for the right credits, not evidence of broad market access. The cost and terms of refinancing remain central to the report's caution. Software amend-to-extend transactions required an average 118 basis-point coupon step-up, versus 5 basis points for other sectors, alongside tighter documentation and increasingly common omni-blocker provisions. Mid- to low-B-rated software loans maturing after 2028 trade at 470-540 basis points, compared with an approximately 350-basis-point adjusted average coupon on pre-year-end-2028 maturities; refinancing at current levels therefore implies a roughly 120-190 basis-point step-up. Morgan Stanley stresses that fundamental performance is the first-order determinant of refinancing access, supplemented by sponsor support, lender composition and availability of new money. Stronger credits can refinance or extend; weaker borrowers face wider spreads, tighter protections and a greater likelihood of distressed alternatives. Recent transactions illustrate that divergence. Borrowers completing par refinancing or amend-to-extend transactions traded at an average of 96 points three months before completion and gained 2.8 points by completion, while defaulting borrowers traded around 50 points at default. Four outright refinancings involved generally higher-quality B2/B3 borrowers or companies seen as having stronger protection from AI disruption. By contrast, the five defaulted software and adjacent issuers had high leverage, weak interest coverage, minimal free cash flow and declining revenue; their near-term maturities led to PIK interest, priming transactions or distressed exchanges. The average defaulted loan fell 6 points, with a median decline of 11 points, in the 90 days before default. Morgan Stanley believes maturity extensions buy time but do not eliminate medium-term risk. About $90 billion of software loans, or roughly 36% of the cohort, mature over the next three years, versus 20% for the overall loan index. Focus is shifting from the reduced 2027 wall to the $48 billion 2028 cohort across 31 issuers. The remaining debt is lower quality: 74% of 2028 maturities are rated B- or below, rising to 78% for 2029. The institution cautions that recent refinancing success may reflect selection bias because stronger borrowers likely came to market first. Despite resilient reported earnings—10 software companies in its fundamentals universe showed median double-digit EBITDA growth in the second quarter—Morgan Stanley sees AI disruption as a longer-dated uncertainty not yet fully visible in top-line results. The default outlook remains cautious. Technology BSL trailing-12-month defaults reached an estimated 7.7% as of August, up from 6.3% a year earlier, largely reflecting leveraged capital structures under high rates rather than realized AI damage to revenue. Morgan Stanley continues to forecast aggregate defaults of 5.5% in BSL and 8% in private credit. Recent refinancing results have been modestly better than embedded in those forecasts, creating downside risk to the forecast, but the report does not see enough evidence to revise it. Private-credit software defaults were lower at 1.2% on a trailing-12-month basis versus 6.0% for direct lending overall, but software private-credit borrowers had median leverage of 8.1x versus 7.1x across sectors and median cash interest coverage of 1.5x versus 1.8x, leaving them vulnerable if stress intensifies. For CLOs, Morgan Stanley sees near-term benefits but retains a defensive capital-structure view. Improved software sentiment and refinancing progress reduce the likelihood of another indiscriminate collateral-price selloff, limiting potential erosion in market-value overcollateralization and related mezzanine spread widening. A roughly $130 billion HY and leveraged-loan event pipeline, nearly double the roughly $70 billion at the start of the year, should improve collateral availability and ease pressure on weighted-average-spread compression; loans also received $11.49 billion of year-to-date fund inflows, up 41% year on year, and generated a 3.3% total return year to date. However, Morgan Stanley remains up in quality: BB spreads have widened about 90 basis points year to date, but the apparent value is concentrated in lower-quality, less-liquid bonds, while median BBs remain tight. For CLO equity, extensions may preserve near-term interest-only cash flows, but higher debt-service burdens, unresolved business-model uncertainty, difficulty capturing distressed-loan coupon step-ups and exposure to priming risk leave principal-only risk elevated. The report therefore sees limited scope for a durable CLO equity rally and remains cautious on managers with outsized software exposure.

Analysis framework

Morgan Stanley compares loan-price performance across software subgroups, tracks refinancing, amend-to-extend and default outcomes, and analyzes the remaining maturity schedule and credit quality. It then links borrower fundamentals, refinancing costs, documentation terms, sponsor and lender support, and new-money availability to potential default outcomes before assessing implications for CLO collateral, spreads and equity cash flows.

Methodology notes

• Industry AnalysisSupply-demand framework

  Loan-market supply-demand and refinancing-access analysis

  The report assesses whether loan demand, fund inflows and a larger primary issuance pipeline can support refinancing and collateral sourcing without overwhelming market demand.

• Fixed Income and CreditSpread analysis

  Spread, coupon and credit-quality comparison

  Morgan Stanley compares refinancing spreads and coupon step-ups with existing coupons, and evaluates BB and CCC spread dispersion to judge the cost of capital and relative credit risk.

• Fixed Income and CreditDefault-Rate and Recovery-Rate Analysis

  Default outcomes and loan-price behavior

  The report contrasts prices and conditions of refinanced borrowers with those of defaulted borrowers, using default rates and trading levels around default as indicators of credit stress and potential recovery dispersion.

Asset mapping & comparison

Structured mapping from thesis to named assets (strengths, weaknesses, peers, risks).

• Conga Corp.

  Illustrative software refinancing beneficiary

  Strengths

  Secured bank commitments for the acquisition of PROS Holdings and extension of existing debt after an earlier syndicated-market attempt failed.

  Comparison

  Its loan price rose from the mid-70s before refinancing to 98 points following completion, materially influencing average refinancing price performance.

• CoreLogic (Cotality)

  Illustrative refinancing transaction

  Strengths

  Refinanced its full capital structure and extended maturities by roughly three years.

  Weaknesses

  Junior-debt demand was softer.

  Comparison

  Its TLB spread widened from S+350 to S+425.

  Risks

  Further pricing concessions were required.

• Proofpoint

  Illustrative amend-to-extend borrower

  Strengths

  Extended $4.3bn of 2028 TLB maturities to 2030.

  Comparison

  The extension was completed at S+450.

  Risks

  The transaction required extensive documentation changes, including an omni-blocker and restrictions on privately negotiated buybacks.

Key data

• Software-loan rebound3pt from June lows; around 90ptImproved sentiment, but software loans continue to underperform the broader market.
• Pre-2028 software maturities~$50bnReduced from ~$75bn at year-end 2025 through refinancing, extensions, paydowns and discount capture.
• Transactions since April7 refinancings/amend-to-extends and 5 defaultsFive of 12 borrowers addressing upcoming maturities defaulted, including distressed exchanges.
• 2028 maturity wall$48bn across 31 issuers74% of 2028 software debt is rated B- or below.
• Software amend-to-extend coupon uplift118bp average; 112bp medianVersus 5bp for amend-to-extend deals in other sectors.
• Expected aggregate default rates5.5% BSL; 8% Private CreditMorgan Stanley maintains these forecasts despite modestly better-than-expected refinancing outcomes.
• Technology BSL trailing-12-month defaults7.7%Estimated as of August, up from 6.3% one year earlier.
• Software & Services operating metrics25.6% margin, 4.31x interest coverage, 22.0% cash/debt, 4.09x gross leverageCompared with 16.9%, 4.08x, 13.0% and 3.98x, respectively, for the broader market comparison.

Impact & implications

The report sees a more stable near-term backdrop for selected software loans and some support for CLO mezzanine and interest-only cash flows. However, it argues that the benefit is uneven: expensive refinancing and a lower-quality 2028 maturity wall leave weaker borrowers, software-heavy CLO portfolios and lower-quality CLO tranches exposed to medium-term credit stress.

Risks

• AI-driven uncertainty around software business-model durability may ultimately weaken earnings and refinancing access.
• Recent refinancing successes may be affected by selection bias, leaving a weaker remaining maturity cohort.
• Higher coupons, tighter documentation and other concessions may constrain cash flow and financial flexibility after maturity extensions.
• The large, lower-quality 2028 and 2029 maturity cohorts could lead to more defaults or distressed transactions.
• CLOs may be vulnerable to priming and lower recoveries in aggressive liability-management exercises.

What to watch

• The next wave of software refinancing transactions, particularly the remaining 2027 maturities and the larger 2028 cohort.
• Whether resilient earnings and cash flow persist as AI disruption concerns evolve.
• Sponsor liquidity support, incumbent-lender cooperation and third-party new-money participation in restructurings.
• The pace of software defaults in BSL and whether BSL stress begins to transmit to private credit.
• Loan supply, CLO issuance and asset-spread trends affecting CLO weighted-average spreads and equity carry.