Morgan Stanley Sees AI-Related Funding Expanding to 15% of All Credit Deals

Private credit funds may be forced to sell their highest-quality loans to software companies at a discount as banks tighten their grip on financing. The comments point to reduced liquidity and pricing pressure in the private credit market, especially for BDCs and software-related lending. The article is commentary from Diameter Capital Partners' Scott Goodwin at Bloomberg's Global Credit Forum, with no specific transaction or dollar amount disclosed.

Analysis

The important second-order effect is not just tighter financing for private credit funds, but a forced repricing of collateral quality across the ecosystem. If banks are extracting the best assets, BDCs are left with a lower-average-quality book and less flexibility to rotate risk, which compresses returns even before any credit losses show up. That tends to widen dispersion: platforms with scale, lower funding costs, and better origination access should consolidate share, while smaller vehicles face a “good assets out, bad assets in” trap.

The software angle matters because this is a hidden subsidy to venture-backed and mid-market tech borrowers that can refinance away from expensive private credit only when they are already outperforming. Expect stronger issuers to opportunistically term out debt or use the window to raise incremental capital, while weaker issuers lose access and are forced into dilution or covenant stress over the next 6-18 months. In other words, the market may be underestimating how quickly funding bifurcates inside software, with the highest-quality names enjoying cheaper optionality and the rest seeing a harsher capital stack.

The most vulnerable position is in higher-yield BDCs with elevated exposure to sponsor-backed software and limited unsecured funding. Their downside is not a single default event; it is NAV erosion, spread compression on new originations, and a slower recovery in fee income as deal turnover falls. A reversal would require banks to ease risk appetite or a renewed pullback in capital markets that makes private credit indispensable again; absent that, the trend can persist for several quarters because it is driven by relative funding cost, not a cyclical shock.

The contrarian view is that this is mildly bearish for private credit optics but not necessarily bearish for private credit economics overall. If banks are only taking the cleanest paper, private credit funds may actually improve realized return persistence on the remaining book, while originators with deeper sourcing can replace lost top-tier loans with higher spreads. The real tell is whether asset sales remain isolated to the very best credits or broaden into average-quality loans; the latter would signal a more material liquidity squeeze and a much more tradable dislocation.

Key Decisions for Investors

• Short a basket of lower-quality BDCs versus a long basket of scaled alternatives over 3-6 months; target relative underperformance as portfolio quality and NAV pressure become visible.
• Consider long duration/quality software exposure on any pullback in profitable names with balance-sheet flexibility; the next 6-12 months should favor issuers able to refinance on better terms while weaker peers are diluted.
• Avoid or underweight BDCs with concentrated exposure to sponsor-backed software and high secured-funding reliance; risk/reward is poor if spread compression and asset churn continue into the next two quarters.
• For traders seeking convexity, buy put spreads on a vulnerable BDC ETF or individual names ahead of earnings/NAV updates; the catalyst is likely gradual rather than event-driven, so use 2-4 month maturities.