Underwriting Software Loans Used to Be Easy. Now Comes The Hard Part: AI Risk

For most of the past decade, lending to a software company was the closest leveraged finance had to a sure thing – recurring revenue, sticky customers, cash flow you could count on. Now the same underwriters are staring at seven-year term sheets and an existential question they are not prepared to answer: Will this business still exist in its current form when the loan comes due?

AI disruption fears are increasingly reshaping credit deal structures in the software industry, according to market participants. The expectation is that loan agreements will progressively include shorter maturities, amortization, higher pricing benchmarks and tighter documentation.

Coming into 2026, software had long been “a darling” of the credit markets and one of the sector’s most frequent issuers, particularly in the loan market, since sponsor ownership pushed borrowers toward leveraged loans rather than high yield, said Anthony DeRosa, managing director in leveraged finance at UBS.

That ended in March, when “a wave of critical headlines hit the software sector creating a ‘sell everything mentality’ among credit investors,” DeRosa added.

The weighted average yield on the 50 largest high-yield software bonds widened by roughly 200 bps from January to late March before partially recovering, according to an Octus quarterly report.

While the market has eased from the March selloff and participants are starting to evaluate each business separately, pricing new risk for many software companies remains difficult, fueling expectations that many of these loan deals will need to undergo structural changes to clear.

A handful of software borrowers are now looking to issue debt, providing an early test for investor appetite and what terms they are willing to accept.

Notably in the market last week was a $5.3 billion refinancing for Cotality, fka CoreLogic, which provides software services for the real estate and mortgage industry. The debt package underwent multiple covenant revisions beyond its July 16 pricing deadline after failing to attract sufficient demand.

The JPMorgan-led offering ultimately resized to a $2.8 billion five-year first lien loan, $1.65 billion five-year first lien notes and $800 million 5.5-year second lien notes, following investor pushback over the company’s high leverage and disruption risk, Octus reported.

“The market isn’t closed to all software companies, but it is closed to those with worse market structures and covenants,” said John Yovanovic, co-head of leveraged finance at MetLife Investment Management.

“Given how the fundamentals look, there’s a structure that works, but it’s not the structure of the debt that’s currently in the market,” Yovanovic added.

Tenors are compressing. A five-year new issue versus the customary seven could become more common, DeRosa said, as underwriters are increasingly structuring loans for companies when nobody can confidently predict their performance outlook.

Two investors said they even expect maturities to shrink from five-to-seven-year loans to three or four years, with amend-and-extends dominating for names that cannot refinance cheaply.

Just this week, Proofpoint, a cybersecurity company backed by Thoma Bravo, launched a $5 billion A&E via Goldman Sachs to extend its first lien SOFR+300 bps term loan debt due 2028 by two years, with pricing expected in the low SOFR+400 bps area, Octus reported.

Even with shorter maturities for new deals, investors are weighing the risk that they will not be able to exit the debt when it comes due. A top concern is that the majority of software companies will not be sustainable over the next few years, one lender said, given how rapidly the sector has been disrupted since March.

Even if a company is labeled as a “winner” and deemed more defensive against AI headwinds, many future deals associated with software will need a discount, according to a leveraged finance banker. However, for certain riskier companies, the banker cautioned that no pricing will be wide enough to justify a deal.

For well-performing software businesses with less leverage and a good free cash flow story, the cost of new debt will still be 50 to 100 bps wider than pre-disruption levels, said DeRosa, noting Imprivata as a good reference point.

The healthcare software company’s $1.33 billion term loan B was repriced from SOFR+300 bps to SOFR+375 bps and 99 OID, extending maturity two years to 2029.

A strong software company is trading around 96 to 97, versus par in other sectors, DeRosa added. A good portion of the curve still sits in the low-to-mid-90s while investors dissect winners and losers.

Another potential shift in deal structure to reduce lender risk could be more amortization, according to market participants. For more complicated refinancing deals, DeRosa said he expects amortization to appear more frequently, especially in credits where there is uncertainty about its future performance.

Amortization levels are typically around 1% per year, but could step up to anywhere from 2.5% to 5%, according to an investor.

Drafting documentation for private software deals has become a more intensive process, requiring lenders to perform additional diligence on the underlying business.

Tighter docs are “really table stakes to get a [software] deal done,” with the focus on enhanced liability management protections, such as J.Crew, Chewy and Serta blockers, as well as tighter baskets regarding leakage, according to DeRosa.

Some investors also expect software deals to include less restricted payment capacity and less ability to raise additional parity or senior debt.

Another part of the equation is leverage, DeRosa added. The backdrop leading up to 2026 allowed software borrowers to lever up based on growth potential rather than current free cash flow. Private credit’s post-Covid boom took that further with annual recurring revenue financings, lending on revenue multiples to companies with no profits and no FCF.

Today, however, that availability has shrunk. Where leverage on first and second lien deals once stood above 7.5x, structures are now gravitating toward all-senior with less leverage, DeRosa continued.

Although sources say activity in the software sector remains mostly muted while issuers evaluate what structure works best, some companies are premarketing deals, hoping to successfully refinance near-term maturities.

Sophos, a cybersecurity provider owned by Thoma Bravo, is facing a March 2027 maturity after several private credit firms passed on a $2.5 billion refinancing, despite a steep increase in yield. Thoma Bravo is now in talks over an A&E with existing lenders via Goldman Sachs for the outstanding $2.1 billion loan.

As companies have reported earnings since the selloff, market participants are increasingly able to differentiate which businesses are continuing to perform well among the bifurcation.

“We’re now seeing early innings of a winners and losers mindset emerging,” DeRosa said. “And if you’re going to be an issuer facing the market, you need to have a story on AI.”

The “winners” are typically businesses with domain expertise that is hard to replicate, while the “losers” are the more commoditized businesses that are not embedded deeply into workflows.

“There are components of the software sector that are still growing and still generating free cash flow, and we are starting to separate those,” said Mike Best, high-yield portfolio manager at Barings.

Names that control sensitive data or are woven into larger systems sit at the top of the food chain, with software embedded in healthcare or hospital systems having the best defensive position, especially compared with accounting or CRM software, according to a leveraged finance banker.

However, sources emphasized that across the bifurcation in the market, even the strongest names are facing scrutiny from investors and clients who remain cautious.

One deal facing lender pushback in premarketing is a $1.35 billion loan refinancing for Clearlake-owned email marketing software company Constant Contact. Some existing lenders are seeking a paydown and higher pricing to extend the debt, while others are advocating for a bond component to diffuse loanholder software exposure.

For now, many software borrowers are generating enough cash flow and maintaining manageable near-term leverage, according to the Octus quarterly report. But they face the risk that the AI displacement narrative develops further by the time their 2027 and 2028 maturities come due.

With those maturities approaching, DeRosa expects a substantial amount of refinancing activity over the next 18 months.

Until then, the structural changes remain projections rather than executed terms. But the direction is more defined, DeRosa said, and the strongest credits are expected to lead the market out. They will just be leading it out on different terms than they came in on.