In a significant shift within the financial landscape, technology companies are poised to borrow substantial sums—potentially hundreds of billions of dollars—as they strive to enhance investments in artificial intelligence. This anticipated influx of debt has prompted lenders and investors to ramp up measures to safeguard their interests, particularly as concerns about default risk increase.
In recent weeks, an observable trend has emerged, with banks and money managers actively trading derivatives that provide protection against defaults by individual tech firms, often referred to as “hyperscalers.” The demand for credit protection has surged, driving up the cost of credit derivatives on Oracle Corp.’s bonds more than double since September. According to Barclays credit strategist Jigar Patel, trading volume for credit default swaps (CDS) associated with Oracle skyrocketed to approximately $4.2 billion over the six weeks ending on November 7, a stark rise from less than $200 million during the same timeframe in the previous year.
John Servidea, co-head of investment-grade finance at JPMorgan Chase & Co., noted a resurgence in interest for single-name CDS, echoing trends seen in the market. Although hyperscalers maintain high credit ratings, their rapid growth as borrowers has led to increased exposure for investors, thereby intensifying discussions surrounding hedging strategies.
While the current trading activity in this domain remains modest compared to the overall debt expected to flood the market, the increasing inclination towards hedging indicates how these tech companies are rapidly becoming central to capital markets amid their ambitious ventures into AI.
JPMorgan strategists project that investment-grade companies may issue around $1.5 trillion in bonds over the next several years. Recent months have seen a wave of significant bond sales linked to AI, with notable transactions including Meta Platforms Inc.’s $30 billion note issuance in late October—marking the largest corporate bond offering of the year—and Oracle’s $18 billion offering in September.
These firms, along with utilities and other organizations associated with AI, dominate the investment-grade market, as highlighted by a recent JPMorgan report. This trend has seen them replace banks that traditionally held the largest market share. The broader debt markets, including junk bonds, are also expected to witness an influx of borrowings, driven by the necessity of establishing vast global data centers.
Interestingly, banks have emerged as some of the primary buyers of single-name credit default swaps on tech companies, responding to a significant increase in their exposure to this sector. Additionally, equity investors are clinging to these derivatives as a cost-effective strategy to hedge against potential declines in stock prices. For instance, the cost of protection against Oracle’s default within a five-year period hovered around 1.03 percentage points, amounting to approximately $103,000 annually for every $10 million in bonds covered. By contrast, a put option protecting against a nearly 20% drop in Oracle’s shares by the end of the following year would cost roughly 9.9% of the underlying value.
This surge in interest comes amid unsettling findings from an MIT initiative revealing that 95% of organizations are witnessing no return from their generative AI investments. While current major borrowers are often established companies with significant cash flow, the technology sector has a history of rapid evolution. Past giants, like Digital Equipment Corp., have fallen into obscurity, illustrating that seemingly stable bonds can become risky ventures if anticipated profits from data centers fail to materialize.
In light of this, credit default swaps related to Meta Platforms began trading actively for the first time following its substantial bond issuance. CoreWeave, another player in the AI space, also saw its derivatives trading ramp up, particularly after its shares dipped due to an unfavorable revenue forecast.
Reflecting on the broader context, trading volumes in high-grade single-name credit derivatives have not yet returned to pre-financial crisis levels, a trend attributed to the evolution of financial instruments and increased liquidity in credit markets. Sal Naro, chief investment officer at Coherence Credit Strategies, views the recent uptick in CDS trade as a transient phenomenon, tied to the current data center expansion.
Despite the temporary nature of this activity, the overall volume of credit derivatives related to individual firms rose by about 6% over the six weeks ending November 7, reaching around $93 billion, according to Barclays. Dominique Toublan, head of US credit strategy at Barclays, confirmed that interest in these financial instruments is indeed on the rise.
This evolving landscape reflects the intricate balance between opportunity and risk as tech giants increasingly take the helm in reshaping the global economy through AI, prompting both enthusiasm and caution within the financial markets.
