UBS Warns of Overheating in AI-Fueled Private Credit Boom

Private credit lenders are providing significant funding for AI development, with $450 billion loaned to the tech sector as of early 2025, up $100 billion from a year earlier. However, this rapid growth raises concerns about overheating, as non-bank lenders push further into the mainstream. Investors should monitor the health of the asset class, with a warning sign being the rise of payment in kind income, which allows borrowers to defer cash interest payments.

Private credit lenders are playing a significant role in funding artificial intelligence (AI) development, with $450 billion loaned to the tech sector as of early 2025, up $100 billion from the previous year [1]. This rapid growth has raised concerns about overheating, as non-bank lenders push further into the mainstream. UBS Global Research, in a recent note, highlighted the potential risks associated with this trend [1].

The surge in private credit funding for AI is driven by large tech firms seeking capital to fulfill their growing needs. Microsoft Corp., Amazon.com Inc., Google-parent Alphabet Inc., and Meta Platforms Inc. plan to spend over $344 billion this year, primarily on AI initiatives [1]. OpenAI, for instance, is looking for new ways to finance its AI data center construction, with CEO Sam Altman expecting to spend trillions [1].

However, this growth comes with risks. Infrastructure and asset-backed financing deals have taken off, but the limited amount of buyout activity has led direct lenders to explore new areas of opportunity. In the first quarter of 2025, private credit funds added $70 billion, indicating the asset class's growing appeal [1]. The addition of alternative assets to 401(k)s is expected to open up trillions more in capital, further fueling this growth [1].

Investors should keep a close eye on the health of the private credit asset class. One key warning sign is the rise of payment in kind (PIK) income, which allows borrowers to defer cash interest payments [1]. In the second quarter, PIK income in business development companies (BDCs) reached the highest level since 2020, climbing to 6% [1]. This trend could indicate that borrowers are struggling to meet their cash flow obligations, raising concerns about the asset class's sustainability.

While private credit lenders are providing much-needed capital to the AI sector, investors should remain vigilant about the risks associated with this rapid growth. The rise of PIK income is a clear signal that borrowers are facing financial challenges, and investors should be prepared to navigate these potential headwinds.

References:
[1] https://www.bloomberg.com/news/articles/2025-08-18/private-credit-powered-ai-boom-at-risk-of-overheating-ubs-says