Traders Seek Protection Amid AI Debt Surge: Credit Weekly
As demand surges for credit protection, the cost of credit derivatives linked to Oracle Corp. has significantly risen since September. The escalating interest from lenders and investors coincides with the technology sector’s plan to borrow substantial amounts for artificial intelligence investments.
Increasing Demand for Credit Protection
Since September, the cost of credit derivatives associated with Oracle Corp. has more than doubled. Recent reports indicate trading volumes for credit default swaps related to Oracle reached approximately $4.2 billion in the six weeks leading up to November 7. This marks a substantial increase from under $200 million during the same timeframe last year, according to Barclays Plc strategist Jigar Patel.
Shifting Investor Sentiments
John Servidea, JPMorgan Chase’s global co-head of investment-grade finance, noted a revived interest in single-name credit default swaps (CDS). Despite Oracle’s strong credit rating, exposure to these firms has prompted increased discussions around hedging risks. The rise in demand reflects tech companies’ growing presence in capital markets as they expand their influence through AI.
Projected Bond Issuance
Investment-grade companies may issue approximately $1.5 trillion in bonds over the next few years, according to JPMorgan strategists. Recent large bond offerings, including a $30 billion issuance by Meta Platforms Inc. and an $18 billion offering from Oracle, underscore this trend.
- Meta Platforms Inc.: $30 billion bond sale (October)
- Oracle: $18 billion bond offering (September)
These tech firms, along with others in the AI sector, have displaced banks as the dominant players in the investment-grade market, a shift highlighted in a recent JPMorgan report.
Global Implications
As companies invest in thousands of data centers worldwide, they will also tap into junk bonds and other significant debt markets. Banks are increasingly purchasing single-name CDS for tech companies to hedge their rising exposure, reflecting a cautious approach amid economic uncertainties.
Cost of Protection
As of Friday, protection against Oracle defaulting over the next five years cost approximately 1.03 percentage points. This translates to about $103,000 annually for every $10 million in bonds protected. In contrast, a put option for Oracle shares falling 20% by the end of next year is substantially more expensive.
| Protection Type | Cost |
|---|---|
| Credit Default Swap (5 years) | $103,000/year per $10 million |
| Put Option (20% drop) | $2,196 per 100 shares |
Concerns Amid AI Boom
Despite high cash flow in leading firms, the volatility of the technology industry raises concerns. An MIT report revealed that 95% of organizations reported zero returns from generative AI initiatives, highlighting the risks associated with these investments.
Market participants have observed that bonds considered safe today may become risky as profits diminish. The introduction of credit derivatives tied to firms like Meta Platforms Inc. illustrates the evolving landscape of the credit market.
Future Trends in Credit Derivatives
Although the current surge in single-name CDS trading may be temporary, traders expect increased activity. Over the last six weeks ending November 7, volume for credit derivatives linked to individual companies has risen by about 6%, reaching nearly $93 billion compared to the same period last year.
Industry experts indicate a growing interest in these financial instruments, particularly as technology firms shape the market amid the ongoing AI revolution.
