AI Gold Rush Sparks Lending Caution
Global technology companies are preparing to borrow hundreds of billions of dollars to fuel their artificial intelligence ambitions, but lenders and investors are increasingly seeking protection against potential failures. Banks and money managers are actively trading more derivatives that provide payouts if major tech companies, known as hyperscalers, default on their massive debt obligations.
Oracle Protection Costs Double
The demand for credit protection has more than doubled the cost of credit derivatives on Oracle Corporation's bonds since September. According to Barclays Plc credit strategist Jigar Patel, trading volume for credit default swaps linked to the company surged to approximately $4.2 billion over the six weeks ended November 7. This represents a dramatic increase from less than $200 million during the same period last year.
John Servidea, global co-head of investment-grade finance at JPMorgan Chase & Co., confirmed the trend, stating, "We're seeing renewed interest from clients in single-name CDS discussions, which had waned in recent years. Hyperscalers are highly rated, but they've really grown as borrowers and people have more exposure, so naturally there is more client dialogue on hedging."
AI Bond Sales Flood the Market
While current trading activity remains modest compared to the expected debt influx, the growing hedging demand signals how technology firms are dominating capital markets as they attempt to reshape the global economy through artificial intelligence. JPMorgan strategists estimate that investment-grade companies could sell around $1.5 trillion of bonds in the coming years.
Recent weeks have witnessed several massive AI-related bond sales, including Meta Platforms Inc. selling $30 billion of notes in late October - the largest corporate issue of the year in the United States - and Oracle offering $18 billion in September. A JPMorgan report last month revealed that tech companies, utilities, and other AI-connected borrowers have now become the largest segment of the investment-grade market, displacing banks that traditionally held that position.
Multiple Factors Driving Protection Demand
Traders indicate that banks are among the biggest buyers of single-name credit default swaps on technology companies, as their exposure to the sector has surged dramatically in recent months. Another significant source of demand comes from equity investors seeking relatively inexpensive hedges against potential stock declines.
Data from ICE Data Services shows that buying protection against Oracle defaulting within the next five years cost approximately 1.03 percentage points as of last Friday, equating to about $103,000 annually for every $10 million of bond principal protected. In comparison, purchasing put options to hedge against Oracle shares falling nearly 20% by next year's end would cost about $2,196 per 100 shares, representing approximately 9.9% of the protected share value.
Valid Concerns Behind the Caution
The cautious approach from money managers and lenders appears justified. An MIT initiative released a report this year indicating that 95% of organizations are seeing zero return from their generative AI projects. While current major borrowers typically have strong cash flows, the technology industry remains notoriously volatile. Historical examples like Digital Equipment Corporation demonstrate how industry leaders can rapidly become obsolete.
Bonds that appear secure today could become significantly riskier over time, particularly if profits from data center investments fail to meet current expectations. The market has already seen credit default swaps tied to Meta Platforms Inc. begin active trading for the first time following its substantial bond sale. Similarly, derivatives connected to CoreWeave have seen increased trading activity, with the company's shares tumbling recently after it lowered its annual revenue forecast due to customer contract delays.
Barclays' Dominique Toublan summarized the situation: "Activity has picked up. There's definitely more interest." Overall volume for credit derivatives tied to individual companies increased by approximately 6% over the six weeks ended November 7, reaching about $93 billion compared to the same period last year.
