Key Takeaways
- Debt investors are increasingly concerned as major tech companies expand borrowing to fund AI advancements.
- Credit derivatives for large tech firms are surging, with notable trading activity in Alphabet and Meta Platforms.
- Projected borrowing by hyperscaler tech companies is expected to reach $400 billion in 2023, raising worries about their credit risk.
Concerns Over Tech Borrowing for AI Growth
Investors are expressing alarm over the rising debt levels among major technology firms as they compete to develop powerful artificial intelligence (AI) technologies. This concern has revitalized interest in credit derivatives, which allow banks and investors to hedge against the risks of borrowers taking on excessive debt. A year ago, credit derivatives tied to high-grade Big Tech companies were nearly nonexistent, but they have quickly become among the most actively traded contracts in the U.S.
Recent data shows that trading activity in credit derivatives for firms like Alphabet Inc. and Meta Platforms Inc. has recently surged. Currently, contracts linked to Alphabet’s debt are valued at approximately $895 million, while those tied to Meta stand at around $687 million. This trend is attributed to anticipated investments exceeding $3 trillion toward AI, much of which will depend on borrowed funds.
Prominent investment figures, like Gregory Peters of PGIM Fixed Income, caution against being overly exposed to the volatility of these investments. There has been a notable increase in the number of dealers offering credit default swaps (CDS) for prominent tech firms, with Alphabet experiencing a jump from one dealer last year to six dealers currently.
While the hyperscaler tech companies, which include the likes of Google and Amazon, are currently managing to secure funding without much hassle—evidenced by Alphabet’s recent $32 billion debt sale—investor enthusiasm raises flags. Expectations suggest that borrowing by hyperscalers may soar to $400 billion in the coming months, significantly higher than previous years. Alphabet alone is projecting capital expenditures of up to $185 billion to support its AI projects this year.
Concerns about potential risks are burgeoning, as investment firms like Altana Wealth have bought protection against default for companies like Oracle. The costs for such protections have escalated from 50 basis points a year to approximately 160 basis points.
Banks underwriting this burgeoning tech debt have also been active buyers of single-name CDS to safeguard their balance sheets. As project financing grows in complexity and urgency, this protective activity is expected to rise. Some hedge funds see the demand for these derivatives as an avenue for profit, especially since many of the largest tech firms maintain relatively low leverage.
However, caution should be exercised, as rapid bond sales might indicate complacency regarding credit risks. Portfolio managers highlight that the sheer scale of debt could eventually affect these companies’ credit profiles negatively. As credit markets navigate this uncharted territory, it remains crucial for investors to monitor the balancing act between growth and risk in the tech sector.
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