'One day it'll really buckle:' A $20 billion CIO sees contagion risk from stress in private credit

• Software pain could spread across the broader private credit market, according to Victor Khosla.
• The CIO said he sees contagion risk stemming from the sell-off in software stocks.
• Software accounts for around 40% of all PE-backed loans, according to one recent analysis.

Pain in the software sector runs a serious risk of rippling the entire private credit market, according to one CIO who manages more than $20 billion in assets.

Victor Khosla, the founder of Strategic Value Partners, flagged the risk of financial contagion in the US's private credit sector, an area that has worried more investors recently after Blue Owl said it was permanently halting withdrawals from one of its funds. The move drew some comparisons to how lenders froze funds leading up to the last financial crisis.

But recent pressure on the software sector, which is heavily financed via private markets, has shone a harsher light on some of its vulnerabilities, Khosla said in an interview with Bloomberg this week.

In particular, he pointed to a recent report from UBS, which estimated that private credit defaults could rise as high as 15% if AI disruption in markets ends up being more "rapid and aggressive" than expected.

Software accounts for around 40% of all private equity-backed loans outstanding, according to a recent Bloomberg analysis.

"I do think, though, software is a big stick. You know, the credit market has had all these sticks being dropped on it, and one day, it'll really buckle," Khosla said, later pointing to a similar scenario in the mid-2010s, when energy prices crashed and sent yields on riskier private debt soaring.

"So the contagion risk in credit — yeah, worry about it," he added.

Software volatility is coming at a time when the private credit space already appears to be under pressure.

Yields on private credit are higher, a sign that investors may be pricing in higher risks. The effective yield of the ICE Bank of America US High Yield Index currently hovers around 6.5%, up around 200 basis points over the last five years.

Defaults in the space have also inched higher. The private credit default rate rose to 5.8% as of the end of January, according to an estimate from Fitch Ratings.

"Underneath the surface, it is really wobbly," Khosla said, later speculating that credit spreads could widen over a three- to six-month period. "This is a fat tail risk now," he later added.