Morgan Stanley Warning: Private Credit Default Rates Expected to Surge to 8%! Is AI Impact the Biggest Catalyst?

The Daily Economic News reporter learned that the wave of private credit redemptions in the U.S. continues to ferment. Recently, Morgan Stanley issued a warning: as artificial intelligence technology continues to develop and impact the software industry, the private credit market is preparing for a new round of pressure, with default rates expected to rise to around 8%.

Led by analyst Joyce Jiang, the team stated that although AI has not yet caused a substantial impact on private credit, potential risks are rapidly accumulating, especially related to loans in the software sector. High leverage ratios and weakening cash flow coverage could push default rates to recent highs.

Notably, just a few days ago, Morgan Stanley and Cliffwater LLC both set redemption limits on their billion-dollar debt funds due to investor redemption requests exceeding normal quarterly limits.

According to the Financial Times, in the first quarter of this year, some large private credit funds faced over $10 billion in redemption requests, involving institutions such as Blackstone, BlackRock, Cliffwater, Morgan Stanley, and Monroe Capital.

AI Reshapes Software Industry Ecosystem, Private Credit Faces Default Pressure

Recently, Morgan Stanley explicitly pointed out in a report that as industry transformation driven by AI reshapes the software sector, the private credit market is preparing for a new round of pressure. The direct loan default rate is expected to rise to about 8%, approaching the peak levels seen during the COVID-19 pandemic.

The report states that the credit fundamentals of loans in the software industry are the most fragile across the entire sector, showing dual pressures of high leverage and low debt service coverage. Joyce Jiang’s team wrote that software loans have the highest leverage and lowest interest coverage among major industries, with cash flow coverage continuing to weaken, significantly stressing debt repayment capacity.

As this warning was issued, the global credit markets are struggling to cope with the impact of AI on corporate business models, especially in the software industry. For a long time, the software sector has been favored by private credit investors due to its stable income and high profit margins.

Over the past decade, alternative asset managers have significantly increased their exposure to software companies. Morgan Stanley data shows that the sector currently accounts for about 26% of non-listed business development company (BDC) investment portfolios. In private credit collateralized loan obligations (CLOs), exposure to the software industry is also substantial, at around 19%, with many loans maturing soon.

According to global financial tracking firm PitchBook, debt maturities for direct loans in the software sector show a “front-loaded, back-loaded” pattern: 11% of loans will mature in 2027, with the proportion rising to 20% in 2028. If market liquidity tightens and lenders’ risk appetite declines, refinancing costs for software companies will rise sharply, and the difficulty of extending debt maturities will directly increase default risks.

Under risk warnings, market liquidity pressures have already emerged. Just last week, Morgan Stanley and Cliffwater LLC set redemption limits on their billion-dollar private debt funds, another example of industry liquidity tension. Both institutions stated that the core reason for the restrictions was that investor redemption requests far exceeded normal quarterly limits, making it difficult for funds to meet all redemption demands without impacting asset prices.

Hundreds of Millions in Redemptions Sweep Asset Management Giants, Market Risks Under Scrutiny

The redemption restrictions by Morgan Stanley and Cliffwater are not isolated cases.

According to the Financial Times, in the first quarter of 2026, private credit funds under major institutions like Blackstone, BlackRock, Morgan Stanley, and others received a total of $10.1 billion in redemption requests. Funds only paid out about 70% of these requests, with the rest being deferred.

For example, BlackRock’s $26 billion HPS corporate loan fund faced a 9.3% redemption request but only executed a 5% quarterly redemption limit; Blackstone’s flagship private credit fund, with $82 billion AUM, saw redemption requests reach 7.9% in a single quarter, a new high.

The redemption pressure has spilled over into the capital markets, causing related stock prices to fall collectively. Since March (up to March 16), Blue Owl Capital’s stock has fallen 16.97%, with a year-to-date decline of over 40%. Ares Management also dropped more than 10% in March. On March 6 alone, BlackRock’s stock plunged 7.17%, while Blue Owl Capital, KKR, and Ares Management declined 5.09%, 4.46%, and 6.01%, respectively.

Notably, on March 11, KKR publicly stated that direct loans account for 5% of its asset management scale, and its recent poor performance is mainly due to legacy investments and non-first lien investments. “Core operational indicators have not shown substantial slowdown,” said CFO Robert Luin. From the recent market performance, KKR’s stock shows signs of stabilization and recovery.

In response to market panic, multiple institutions have also assessed risk boundaries. Morgan Stanley strategists emphasized that current private credit risks are limited to the industry level and do not constitute systemic risk, with limited spillover effects. The report pointed out that liquidity restrictions in private credit effectively block risk transmission, and banks’ exposure to this sector is defensive, unlikely to repeat the 2008 subprime crisis.

Huatai Securities also noted that private credit is currently in a sector cleanup phase, with short-term pressures expected to persist. However, under a baseline scenario of a soft landing for the U.S. economy, systemic spillover risks are overall controllable, more like a “storm in a teapot” (i.e., localized industry risk).

Some market participants warn that AI’s disruption to the software industry is long-term and uncertain, and the restructuring of revenue models will continue to impact credit quality. Additionally, the increasing proportion of retail investors may lead to liquidity vulnerabilities, further amplifying market volatility. The rapid growth of private credit over the past decade may be coming to an end.

So far, redemption restrictions are still in place. Over the next two weeks, as institutions like Ares Management, Apollo Global, Blue Owl, Oaktree, and Goldman Sachs complete their assessments, redemption volumes are expected to rise further, and liquidity challenges in the private credit market remain unresolved.

[Cover image source: AIGC]