BofA warns AI rally mirrors past boom-bust as defaults hit 6%

Bank of America strategists are drawing a historical parallel for the AI rally that points to boom-and-bust dynamics, not the dot-com era.

European equities face headwinds as Bank of America strategists warned the AI build-out is following boom-and-bust patterns, with private credit defaults already hitting a record 6% in April.

"Our updated perspective points to a meaningful increase in private credit defaults, rising from roughly 4.4% to 9-10%, driven in part by the implications of the AI cycle," Matthew Mish, strategist at UBS, said. Risk is expected to intensify toward year-end and into early 2027 as software businesses experience slowing growth, waning pricing power and margin compression, he added.

Fitch registered a record-high 6% private credit annual default rate in April, with 10 default events occurring that month. Over the 12 months through April, the ratings agency recorded 99 defaults of various kinds, including interest payment deferrals, maturity extensions and payments-in-kind. Software accounts for 19% of assets for middle-market collateralized loan obligations, according to S&P, making it the sector most exposed to the AI-driven disruption. Banks have extended about $300 billion in loans to private credit funds, Moody's data shows.

The spillover risk from private credit into public markets is underappreciated, Mish said, noting that investor bases overlap significantly among insurance companies, foreign investors and retail participants. DoubleLine Capital CEO Jeffrey Gundlach warned last month that June could bring "humongous withdrawal requests" from interval funds, potentially acting as a catalyst for broader market stress. "Beware the ides of June," Gundlach posted on social media.

Software Sector Under Pressure

Salesforce's stock performance on Thursday illustrated the challenges facing the software industry. The company beat profit and revenue estimates but saw its shares decline as multiple Wall Street firms questioned its long-term growth prospects in the face of AI. Bank of America analyst Tal Llani said there is increasing risk that AI labs like OpenAI and Anthropic expand downstream into enterprise applications, directly competing with companies such as Salesforce.

The pressure on software is rippling through private credit markets because the sector supports a large share of securitized loans. UBS's Mish said the AI cycle is driving contract cancellations and compressing margins across software businesses, which in turn raises the probability of defaults on loans backed by those companies.

Retail and Institutional Exposure

Retail investors may not be shielded from the fallout, particularly if stress spreads to banks that have lent to private credit funds. Unicus founder Laks Ganapathi said major asset managers including KKR, Goldman Sachs Asset Management, Apollo, BlackRock and Blackstone have all pushed into retail retirement accounts through private credit products. State pension systems from Kentucky, Arizona, California and Virginia also hold significant private credit exposure, according to the Boston College Center for Retirement Research.

Gundlach pushed back on the idea that stress in private credit would force selling of public securities, noting that stock markets have remained resilient. "The stock market is not in trouble, it's at new highs," he told Bloomberg. "You'd think if there was something to that concept, we'd see more evidence of it."

This article is for informational purposes only and does not constitute investment advice.