AI Capex Boom Puts Credit Markets to the Test

Welcome to Thoughts on the Market. I'm

Andrew Sheets, head of corporate credit research at Morgan Stanley. Today, a

look at a very different type of challenge for credit markets. It's

Friday, November 21st at 6 p.m. in

Singapore.

It's now been well over 15 years since the global financial crisis shook the credit markets to its very core. It's

hard to state just how extreme that period was. How many usual relationships

period was. How many usual relationships and valuation approaches broke. It saw

the worst credit losses in 80 years. I

think and hope that this record will hold for the next 80. This shock,

however, did have a silver lining for the credit market. After a crisis that was driven by bank balance sheets being too large and complex, these shrank and simplified. After companies saw capital

simplified. After companies saw capital markets suddenly shut, they increased their cash levels and often managed themselves more conservatively. The

housing market, long the engine of debt growth in the US, saw much tighter lending standards and less overall borrowing. And so all these trends had a

borrowing. And so all these trends had a common theme, less bond supply. The

credit market has seen numerous bouts of volatility in the years since, but these have generally been driven by concerns around the macroeconomy like the Eurozone crisis or COVID or they've been

driven by company specific issues such as weakness around the oil sector in the mid2010s or the collapse of Silicon Valley Bank in 2023.

The idea that there would be too much borrowing for the level of demand and that this causes market weakness, well, it just hasn't been an issue until that

is now. As we've discussed on this

is now. As we've discussed on this program, there is an enormous increase underway in the amount of capital expenditure by technology companies as they look to build out the infrastructure that supports their cloud

and AI ambitions. Morgan Stanley Equity Research estimates that the largest spenders will commit about $470 billion of spending this year and $620 billion

of spending next year. That's over $1 trillion of spending in just a 2-year period. And it's still growing. We see a

period. And it's still growing. We see a lot of momentum behind this spending as the companies doing it have both enormous financial resources and see it as central to their future ambitions.

But all this spending however will need to come from somewhere. These are often very profitable companies and so we think about half will be funded from their cash flows. The other half well

debt markets will play a big role especially as these companies are often highly rated and so have significant capacity to borrow more. And over the last few weeks those spigots have now

turned on. Several large technology

turned on. Several large technology hyperscalers have been borrowing tens of billions at a clip. and they've been doing this in short succession. There is

some good news here. This new borrowing has been coming at a discount with the issuers willing to pay investors a bit more than their existing debt to take it on. Demand in turn has been very high

on. Demand in turn has been very high for this debt and in most cases this borrowing is still well below anything that could feasibly trigger rating

agency action. But it is raising a very

agency action. But it is raising a very different type of issue. After a long period where generally speaking investors have rarely worried about excessive supply, these are very large

deals coming at very large discounts and they are moving the market. If a double A rated company is in the market willing to pay the same as a current single A, well, that existing single A credit just

simply looks less attractive. As far as problems go, we think this is a generally less scary one for the market to face. But it is a new challenge,

to face. But it is a new challenge, something we haven't encountered for some time and based on the aphformentioned spending plans. It may

be with us for some time to come. Thank

you as always for your time. If you find Thoughts of the Market useful, let us know by leaving a review wherever you listen and also tell a friend or colleague about us today.

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