Investors managing collateralized loan obligations (CLOs) have begun to pare back holdings of software loans, selling debt at discounts and intensifying pressure on an already unsettled segment of the credit market. The selling activity is the latest signal of distress within software and private credit, after a steep repricing episode in January and February tied to fresh concerns about AI-driven disruption.
In recent weeks, several CLO managers have sought ways to reduce software exposure amid the prospect of rating downgrades on high-yield bonds and the risk of future defaults, according to market participants and credit analysts. Managers are wrestling with how best to evaluate AI-related risk at the single-name level while responding to investor unease across the structured credit ecosystem.
What managers are doing
CLOs, which assemble portfolios of small slices of numerous leveraged loans, bought heavily into loans backing software buyouts during the pandemic-era deal boom and subsequent years. That accumulation has left software as one of the most concentrated subsectors in CLO collateral pools. Morgan Stanley estimated software and services represent about 15% of U.S. syndicated CLO collateral as of February 20, with software alone at roughly 12% of holdings - the largest subsector concentration.
Faced with those concentrations and new uncertainty over how AI could reshape demand and competitive dynamics, some CLO managers have been reducing software positions where they are overweight or where refinancing pressure is imminent. "Software is a sector where there is more selling coming from CLO managers than there is buying right now," said Jim Egan, co-head of securitized products research at Morgan Stanley. He noted broadly syndicated loans have elevated exposure to software, which has contributed to the sell-side activity.
Moody's associate managing director Al Remeza said the reductions have been particularly evident where managers needed to address positioning ahead of refinancing windows. "We’re seeing some CLO managers reduce exposure to software - particularly where positions were overweight or ahead of refinancing activity," Remeza said, while adding that other managers view the current market dislocation as a selective buying opportunity for companies judged least vulnerable to AI disruption.
Market pricing and trading activity
Late February and early March trading data from TRACE, the FINRA-developed Trade Reporting and Compliance Engine, shows a mix of investment-grade notes and high-yield leveraged loans tied to certain software companies changed hands at discounts in the range of 89 to 98 cents on the dollar. Among the names cited in these trades were Intuit, Dayforce and Citrix, according to TRACE data compiled for the period.
Those same securities were trading at premiums several months earlier, illustrating the rapid shift in market sentiment. Reuters could not determine which specific CLOs sold particular loans. Dayforce and Citrix did not provide comments in response to requests.
Even as discounts have emerged across parts of the software complex, not every security has repriced materially. For example, the spread on Intuit’s 2033 investment-grade bond remains largely in line with the level at issuance in 2023. Intuit’s credit rating was upgraded by S&P Global to A from A- in October. Still, the company’s equity has not been spared; Intuit shares have fallen about 32% so far this year amid broad unease over AI’s implications for enterprise software.
"We bet the entire company on data and AI nearly ten years ago, when we declared our strategy to be an AI-driven expert platform to deliver done-for-you experiences. Our strategy is working; in the first half of our fiscal year 2026, we delivered 18 percent revenue growth while expanding margins," an Intuit spokeswoman said in an email to Reuters.
Assessing the buyer base and demand dynamics
Despite the presence of discounted paper, the pool of prospective buyers for large software loan packages is thin, credit analysts warn. Many large private credit firms and direct lenders remain cautious about committing capital to sizable software loans in the near term as they face investor scrutiny and rising redemption requests at their flagship funds.
Joyce Jiang, head of U.S. CLO Research at Morgan Stanley, described a CLO community that is methodically developing a framework to assess AI risk on a name-by-name basis. "The majority of the CLO community is really taking its time to think about how to come up with a framework to assess AI risk, more on the single-name level, to really scrub their book to identify which are the names that are more prone to AI risk," she said. That process, Jiang added, means CLOs are unlikely to engage in large-scale dip buying in the near term.
Gavin Zhu, head of U.S. CLO Research at Barclays, echoed the view that managers without heavy software exposure see little incentive to rapidly rotate back into the sector without a clear catalyst. "It’s a bit more difficult to suddenly and opportunistically rotate back into software without a true catalyst. And I think that might be contributing to some of the continued weakness that we see on the loan side," Zhu said.
Broader implications for CLO issuance and private credit
Widening spreads across CLO tranches and increasing investor caution have weighed on transaction activity. Analysts at JPMorgan provided initial estimates that roughly $40 billion to $150 billion of U.S. CLO holdings sit in sectors most associated with AI risk. Separately, JPMorgan expects global CLO loan supply to fall to about $150 billion this year, which would be roughly a 25% decline from the prior year - a contraction driven by declining investor demand amid spread widening, concerns over loan quality and worries about cracks in the broader credit market.
Credit fund managers and analysts said that while some managers are selling selectively, not all CLO players are indiscriminately dumping software loans at steep discounts. The recent selling, they noted, has been concentrated around relatively better-performing loans that have changed hands at modest discounts.
Rishad Ahluwalia, head of CLO Research at JPMorgan, observed that sentiment among investors has turned more bearish in recent weeks as spreads widened and CLO transaction volumes fell. "For CLO managers, the appetite for stressed loans in orphan sectors, like software and services, is weaker," he said.
Where things stand
The market is in a phase of active re-evaluation. CLOs that accumulated meaningful software exposure during the deal boom are now managing concentrated sector risk in an environment where technological disruption - specifically from AI - has become a central variable. Managers are taking differing approaches: some are trimming positions to reduce vulnerability, others are treating reduced prices as selective buying opportunities for what they judge to be less-exposed names.
At the same time, the lender and investor base that might absorb large blocks of software loans is constrained. That dynamic, combined with CLO managers' cautious stance while they construct AI-risk frameworks, contributes to continued pressure on software loans and related spreads.
Summary
CLO managers have increased selling of software loans at discounts as concerns over AI-related disruption prompt a reassessment of credit risk. The activity has contributed to wider spreads, reduced CLO transaction volumes and the specter of lower issuance, even as some managers view the environment as selectively attractive for names perceived as less vulnerable to AI.
Key points
- Software represents a sizable concentration within CLO collateral, estimated at roughly 12% of holdings, making it the largest subsector by concentration.
- Recent trades show some software bonds and loans changing hands at discounts between 89 and 98 cents on the dollar; spreads for CLOs have widened amid investor concern.
- CLO managers are developing single-name frameworks to assess AI risk, and many are hesitant to engage in large-scale dip buying until those frameworks are in place.
Risks and uncertainties
- Buyer base for large software loan packages is thin, which could limit liquidity and support for loans coming to market - a risk for leveraged loan markets and private credit funds.
- Potential wave of rating downgrades and defaults in software and related sectors could increase losses for CLO tranches and stress investor appetite - a risk for structured credit and leveraged loan investors.
- Widening spreads and diminished CLO issuance could exacerbate funding stress for sponsors and borrowers dependent on refinancing - a risk for deal financing across technology and services sectors.