AI is disrupting businesses. Debt could make the damage much worse
U.S. leveraged loans trading at deeply distressed prices have surged to levels not seen since the early months of the pandemic, with technology companies accounting for a large share of the troubled debt.
Artificial intelligence is evolving at a dizzying pace, bringing with it immense promise, from lowering service costs and raising living standards to accelerating economic growth. Yet along the way, it also threatens to destabilize companies whose business models and revenues are coming under pressure.
According to an analysis by JPMorgan, the volume of U.S. leveraged loans trading in "deep distress," meaning at less than 60 cents on the dollar, has reached $65 billion, up from $40 billion a year ago. That represents a 62.5% increase and the highest level since March 2020, when COVID-19 lockdowns sent shockwaves through the economy. In other words, for every dollar a company owes, investors are willing to pay less than 60 cents for the right to collect that debt. The price reflects serious concern about the company's ability to repay the full amount.
Looking at the broader universe of loans trading at 80 cents on the dollar or less, the total volume approaches $140 billion. That is nearly 90% higher than a year ago and just $4 billion below the level recorded in May 2020. It is important to note that distressed pricing does not signal an imminent bankruptcy filing. It does, however, indicate that lenders are willing to accept a significant discount to transfer the risk to another investor.
The concentration in specific sectors suggests that this is about more than a typical credit cycle. The technology sector accounts for approximately 39% of distressed loans, or roughly $54 billion. Software companies alone face more than $100 billion in maturing debt, according to reports, while concerns about AI's impact on their businesses are making refinancing more difficult.
The predicament is relatively straightforward. A company can service a large debt load as long as its revenues remain stable and lenders are willing to refinance its loans when they mature. But if customers can switch to cheaper alternatives, develop their own solutions or reduce their software spending, the revenue outlook becomes much less certain. The debt, meanwhile, does not shrink and still comes due on schedule.
Financing conditions are adding to the pressure, particularly high interest rates. This is where the U.S. government enters the picture.
The United States is contributing to higher borrowing costs as massive budget deficits force the government to issue increasingly large amounts of debt. The resulting increase in supply, combined with uncertainty over the country's fiscal trajectory and concerns about inflation, can push investors to demand higher yields.
The yield on the 10-year U.S. government bond has climbed to approximately 5.3%, a level not seen since 2002. This does not mean investors expect the U.S. government to default. Rather, it means they are demanding a higher return for lending to Washington.
The consequences extend well beyond the federal budget. U.S. government bonds serve as a key benchmark for financial markets, so when their yields rise, companies generally have to offer higher returns to compete for investor capital. Washington's fiscal pressures can therefore feed directly into the cost of corporate financing.
The result is a difficult mismatch. A company that was able to comfortably service its old debt may not be able to afford the cost of refinancing it at today's rates. It may be forced to sell assets, cut investment and staff, or negotiate a restructuring with creditors.
Financial market anxiety can therefore translate into a real-world economic slowdown. The critical question is whether companies can adapt before their debt matures. Developing a new product or changing a business model requires investment, yet capital can be hardest to secure precisely when a company is under financial pressure.
Still, comparisons with the COVID-19 crisis require caution. The figures reflect the volume of debt trading at distressed prices within a specific segment of the credit market. They do not establish that the U.S. economy as a whole is facing a crisis comparable to 2020. Such a conclusion would require looking at the distressed debt as a share of the broader market, who holds that debt and, ultimately, whether defaults are actually rising.
There is nevertheless a broader economic lesson here, and a warning sign for investors and companies alike.
Technology can make an economy more productive while simultaneously undermining the revenues of companies that have built businesses around the old technology. AI may lower costs and create new markets, but it can also make existing products less valuable, force customers to reconsider what they buy and accelerate competitive shifts.
The more heavily indebted those companies are, the less room they have to adapt. A business facing technological disruption can survive if it has time and capital to reinvent itself. When its debt is coming due at the same moment that its business model is under threat, those two things can become the scarcest resources of all.
