By Olivia Fishlow and Rene Ismail
(Bloomberg) --Three of the biggest names in private credit moved to reassure investors this week about the AI risks facing their software borrowers, deploying proprietary "score cards" and outside consultants.
The findings: vulnerability is "medium" and "minimal," and portfolios are "more insulated."
As investors across global markets question the survival of software businesses in the wake of rapid advances in artificial intelligence, Ares Management, Blackstone and Blue Owl Capital sought to quantify the potential damage hidden in their portfolios.
Ares hired an outside consultant for the review, while Blackstone and Blue Owl used their own systems to evaluate their books. The message to investors was similar: the threat is serious, but the senior loans in their funds are largely protected. The asset managers went so far as to highlight software companies that would experience "tailwinds" from AI.
"There is a sharpened focus on this book given the noise in the market," said Ethan Kaye, a research analyst at Lucid Capital Markets. He expects more asset managers to disclose how they are evaluating risks for businesses facing AI disruption.
Software lending makes up about 20% of the loans deployed by business development companies, Barclays analysts including Corry Short estimated, but the actual exposure may be much larger, as many private credit funds label their software loans as something different. That has made it challenging for investors to figure out what's at risk.
Blackstone's flagship private credit fund, known as BCRED, used an internal AI risk score card to comb through its portfolio, finding that less than 5% of investments were facing AI headwinds. The analysis included risks to end markets and business models, the fund said in a filing Wednesday.
"The software sector will have to adapt to AI," Blackstone managers said in a letter to shareholders, adding that they believe they have invested in businesses that are "more insulated from AI-related disruption."
BCRED noted it had incorporated the sharp selloff in software stocks into the analysis, leaving its portfolio with an interest coverage ratio of about 2 times. The fund said that AI could have a low impact or even pose a tailwind for 16% of its software assets.
Ares, meanwhile, said about $1 billion of investments made by its largest publicly traded private credit fund faces at least "medium" risk of disruption by AI. About 85% of its "software-oriented investments" are at low risk, according to a report by an external consultant. Just 1% were deemed high risk.
Ares Capital Chief Executive Officer Kort Schnabel said that some of the businesses can benefit from AI.
"Not all software companies carry the same level of AI disruption," Schnabel said on an earnings call Tuesday. "And in fact, many are embracing AI and seeing enhanced growth."
Over at Blue Owl, managers came to the same conclusion. They went through the exercise of underwriting existing loans with new information, focusing on AI vulnerabilities. The assessment found "minimal" risk in its portfolio, according to a person with knowledge of the review.
"If you took just one step back, you'd probably logically conclude that there's a set of companies that will actually be beneficiaries of AI," Blue Owl co-CEO Marc Lipschultz said on the firm's earnings call Thursday.
There will be some companies that will be harmed but not mortally, while others will "get themselves in more substantial trouble," he added.
For investors, the key will be to figure out the different types of software investments across the different lenders, said Meghan Neenan, the head of non-bank financial institutions for North America at Fitch Ratings.
"I think we will see writedowns of software investments this quarter, given movement in the liquid market," Neenan said. "It will be interesting to see differences in conservatism on this metric across the BDC space."
