(Bloomberg) — After a $300 billion AI debt binge that spanned every corner of the credit market, investors are starting to show some signs of fatigue.
Make no mistake: There’s still appetite for those deals. But bankers have had to work harder to sell them lately, offering more incentives and higher compensation to investors who are spoiled for choice. Just on Thursday, they had the option of buying into Meta Platforms Inc.’s jumbo investment-grade offering, or take more risk and look at the latest leveraged loan deal from CoreWeave Inc.
But there are signs of waning enthusiasm. Meta racked up a peak order book of about $96 billion for a bond sale that’s expected to raise as much as $25 billion, according to people with knowledge of the matter. The last time it tapped the corporate bond market in October, it drew $125 billion of demand for a $30 billion deal.
And lately, investors are demanding more protection. Borrowers are agreeing to repay some or all of the principal on debt before it matures, a clause called amortization that removes risk down the line. More issuers — especially in the junk-bond market — are getting so-called backstops from Alphabet Inc.’s Google, a covenant guaranteeing that a data center lease will be paid even if a tenant defaults. There are also provisions that place a ceiling on building costs.
It all suggests an undercurrent of anxiety around a market that has held up well so far — but is still relatively new and untested. And with estimates that the AI buildout could cost some $3 trillion, the size of the borrowings is only likely to balloon from here.
“At the end of the day, these companies are selling a lot of debt and they’re going to have to pay up to borrow,” said Robert Tipp, head of global bonds at PGIM Fixed Income. “The market, after a spectacular narrowing in corporate spreads to historical tights, is seeing a wall of worry piled up before it.”
Many money managers say there aren’t always conventions for how provisions designed to give lenders more protection should translate to yields and risk premiums on the securities.
“We’re seeing what different investors value when it comes to these financings and how they’re evaluating risk and return,” John Servidea, global co-head of investment grade debt capital markets at JPMorgan Chase & Co. said about data-center debt. “We’re seeing really good demand for these deals but as supply increases, we expect deal terms and structures to continue to evolve.”
And over time, debt buyers have started to get a better grasp of the various risks involved in data-center projects, according to David Kinsley, a senior portfolio manager at Impax Asset Management.
He says investors are asking questions like: “Do you have execution issues? Supply chain or construction delays? Is it a lower-quality tenant?”
They’re also turning away from deals that don’t meet their standards. One investor, speaking anonymously to discuss private deliberations, said they passed on a $14 billion offering for an Oracle Corp. data center in Michigan partly because the bonds are callable. That adds risk for creditors since a borrower can refinance at a lower interest rate once construction is complete.
The need for due diligence is even more important in the riskier parts of the credit market. One thing that helps to put investors at ease is having a connection to a hyperscaler — a company with a massive cloud computing operation — either as a tenant or a backstopper. Of the roughly $27 billion in high-yield debt issued this year to fund AI infrastructure, almost a third of that money is tied to the most valuable publicly-traded company in the world, Nvidia Corp. An entity backed by asset manager Tract Capital has raised more than $8 billion since Febraury to finance construction of a data center in Nevada, where the chipmaker will be a tenant.
Partnering with a tech giant can also help data center developers obtain investment-grade ratings. Earlier this month, Blackstone Inc.-backed QTS sold $4.6 billion of bonds to fund a Microsoft Corp.-tied facility. Moody’s Ratings gave a first-time credit score of Baa2 to the offering — two notches above junk.
The tech behemoths aren’t showing signs of slowing down. Four hyperscalers reported earnings on Wednesday, and they all reiterated their intentions to spend big on data centers and the chips that power them.
Still, there are multiple factors for investors to consider when looking to buy data-center debt, and having a hyperscaler involved doesn’t mitigate all of those risks.
“All data center credits are not created equal,” said Grant Nachman, Chief Investment Officer at Shorecliff Asset Management. “Future tenant quality alone isn’t sufficient. Bondholders need confidence the borrower can build and power the asset, and keep it online. The safest deals meet multiple criteria, and are structured to” pay down debt quickly.
–With assistance from Emily Graffeo and James Crombie.
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