Credit spreads for technology companies driving the AI expansion are widening, with expectations of further expansion later this year as total debt levels rise. This trend could create financial pressure for “neoclouds”—the heavily leveraged infrastructure builders—as well as major hyperscale cloud providers. While the interconnected investment patterns between cloud providers, AI software developers, and chipmakers may help neoclouds mitigate these costs, the sector may still face broader impacts from more expensive corporate debt. In financial terms, a widening spread refers to an increasing gap between the yields of bonds with similar maturities but different credit qualities; this trend typically indicates that investors perceive higher default risks and require greater compensation. Despite significant capital expenditure increases from giants like Google, concerns regarding credit quality are mounting. “As we speak, spreads are widening for hyperscalers, and credit default swaps (CDS) are also expanding significantly,” Torsten Slok, chief economist at Apollo Global Management, told CNBC. “The CDS for Oracle has reached levels seen in 2008, and while CDS for hyperscalers had previously hit lows, the current trend is clearly unfavorable.” Analysts at Mizuho recently highlighted risks regarding wider spreads specifically for smaller, highly indebted neoclouds. “We are observing concerns regarding neoclouds generating negative free cash flow, widening credit spreads, and potential capital raising challenges,” Vijay Rakesh of Mizuho noted in a client communication. According to FactSet data, CoreWeave carries a total debt-to-equity ratio of approximately 739 times, while Nebius stands at 131 and Applied Digital is at 172. In contrast, major cloud providers maintain much lower ratios: Alphabet’s debt-to-equity was approximately 18 at the end of June, Amazon’s is 51, and Microsoft’s was around 30 at the end of March. Despite current volatility, corporate credit spreads are projected to remain wide through 2027. “We expect US credit spreads to remain relatively stable in Q3 before widening in Q4 and continuing to decompress into 2027,” Matthew Mish, head of credit strategy at UBS, stated in a June 24 note. He cautioned that credit returns may not adequately compensate for the risk profile expected in the latter half of the year. Much of the financing for frontier AI technology occurs outside of standard bond markets, sometimes through off-balance-sheet arrangements, leading to calls for increased scrutiny. “We anticipate more nuanced decisions regarding exposure and pricing as the multi-year AI investment cycle progresses,” wrote Amanda Lynam, chief credit strategist at Goldman Sachs, on July 9. She suggested that a diverse array of funding sources—including syndicated credit, private markets, joint ventures, and international capital—will be necessary to meet demand. The debt markets have already shown signs of strain when handling massive issuances from major players; for instance, the secondary market saw disappointing results for bonds issued by Nvidia and SpaceX earlier this month, while Amazon faced higher-than-usual rates, according to The Wall Street Journal on July 12. Furthermore, circular financing risks—such as Nvidia providing backstopping agreements to its neocloud clients—could either buffer or exacerbate the impact of rising costs. “Neoclouds are already finding it difficult to finance investments at the current price point of $50B/GW,” Seaport analyst Jay Goldberg noted on July 15. “Consequently, Nvidia is becoming more directly involved in financing.” To mitigate risk, some neoclouds use specialized debt contracts that leverage the credit ratings of their hyperscale customers. “CoreWeave utilized this strategy for their recent data center capital expenditures,” Paul Meeks of Freedom Capital Markets told CNBC. However, these protections are not universal across the cloud sector. The Bank for International Settlements (BIS) recently warned that heavy reliance on debt and circular financing could trigger a market bust. “The rush to commit early through debt and circular financing increases the likelihood of a bust,” wrote Phurichai Rungcharoenkitkul for the BIS on July 7. The bank’s findings suggest that overinvestment—potentially reaching 1.5 times the necessary level—could cause stress in one firm to cascade through the sector via interconnected financial exposures. This mix of intense competition and mutual investment is causing significant concern for investors. “My primary concern involves the credit quality of companies operating within this competitive landscape,” Dan Alpert, founding partner of Westwood Capital, told CNBC.
Source link
