Heavy spending on artificial intelligence could widen economic outcomes and hit lower-quality loans, the firm says.

One of the world’s largest bond investors is warning that a painful stretch of loan defaults has begun, and that the enormous sums companies are borrowing to build artificial intelligence are making it worse. Pacific Investment Management Co. (Pimco) laid out the warning on Wednesday, June 10, in its latest annual long-term outlook report.

The message was blunt.

“The default cycle is reasserting itself, and we expect significantly higher losses in lower-quality credit such as leveraged and private direct lending,” wrote Daniel Ivascyn, the firm’s chief investment officer, along with colleagues Richard Clarida and Andrew Balls. The firm said plainly that “the credit loss cycle is upon us.”

This is not a minor voice. Pimco manages approximately $2.3 trillion in assets, making it one of the largest fixed-income investors in the world. When a firm that size says losses are coming, lenders and investors listen.

To understand the warning, it helps to define the terms. Leveraged loans are loans made to companies that already carry heavy debt. Private direct lending, often called private credit, is when investment funds rather than banks lend money directly to mid-sized businesses. Both areas have ballooned over the past decade as investors chased higher returns, and Pimco says underwriting standards loosened along the way.

In other words, lenders got less careful about who they handed money to.

Now the bill is starting to come due. Pimco expects those weaker corners of the market to face a wave of defaults as companies struggle to keep up with their debts.

The artificial intelligence boom is a central part of the story, and not in the way most headlines frame it. Pimco estimates that AI-related debt issuance is running at roughly $100 billion every quarter. The companies building the massive data centers behind AI are increasingly financing those projects with borrowed money rather than cash on hand. Capital spending is surging while free cash flow moves in the opposite direction.

Pimco’s view is that this buildout could widen the gap between winners and losers over the next several years, leaving weaker, more heavily indebted borrowers exposed.

There is a warning sign that most people are missing, according to Pimco.

Official high-yield default rates have hovered around their long-run average of roughly 4%, a number that looks calm on the surface. Ivascyn argues that figure is misleading. He points to what the firm calls “shadow defaults,” where a struggling borrower quietly renegotiates or amends its loan terms to avoid an official default. The trouble never shows up in the headline statistics, but the company is still in distress.

Another red flag is the growing use of payment-in-kind financing, where a borrower pays interest with additional debt instead of cash. It is the financial equivalent of paying one credit card with another. It buys time, but it also increases the eventual burden.

Pimco also flags a striking disconnect. Credit spreads—the extra interest investors demand to hold risky debt instead of U.S. Treasury securities—remain near historically low levels. On the surface, that looks like confidence. Underneath, Pimco frames it as complacency, with investors getting paid very little to take on rising risk.

The firm is careful to note that this is not a repeat of the early-2000s telecom bust, when companies borrowed aggressively to lay fiber-optic networks that later went underused. Today’s AI financing is more disciplined, Pimco says, and the opportunity in AI-related lending is real.

But only for investors who can tell the difference between well-funded borrowers with genuine revenue and overleveraged operators chasing the hype.

The everyday stakes are larger than they might seem. Pension funds, insurance companies, university endowments, and retirement accounts have poured money into private credit over the past decade, attracted by higher yields and steady payouts. A wave of defaults would reduce those returns.

The borrowers most at risk are often smaller and mid-sized businesses that depend on private lenders for capital. Those same firms are also facing higher financing costs, elevated energy prices, and ongoing economic uncertainty. If lending conditions tighten, many could scale back hiring, delay expansion plans, or reduce investment, creating ripple effects throughout local economies.

For now, Pimco says the risk of a broad financial crisis remains low. This is not a 2008-style financial meltdown in the making. Instead, the firm sees a slower grind of mounting losses concentrated among the weakest borrowers and the most aggressive lenders.

Its recommendation is straightforward: favor higher-quality credit, maintain discipline, and pay close attention to who is on the other side of every loan.

The broader lesson lands at the center of today’s AI debate. The technology’s promise may be real, but the money funding much of the buildout is increasingly borrowed. Pimco’s warning is that not every borrower participating in the boom will be able to pay it back.

JBizNews Desk — Markets

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