CoreWeave credit default swaps hit distress levels as investors sour on AI debt

CoreWeave credit default swaps hit distress levels as investors sour on AI debt

CoreWeave's credit situation has experienced a significant downturn as of Thursday, coinciding with a broader sell-off of AI-related equities.

The neocloud company has accrued over $51 billion in debt and obligations to support its AI infrastructure expansion, leading to mounting discontent among both stock and bond investors. Worries surrounding potential overextension in AI-related spending are at the forefront of this concern.

Consequently, yields on CoreWeave's debt are on the rise, exemplified by the yield to maturity on its 9.75% bond due in 2031, which has reached 15.78%. It is important to note that bond yields and prices move inversely. In parallel, the spread on its five-year credit default swaps—essentially a form of insurance against default—has surged, at one point exceeding 1,140 basis points, and most recently recorded at 1,088 bps. This marks a remarkable increase of 33% from the previous week and a staggering 177% compared to one year ago.

The apprehension surrounding credit is now affecting AI equity markets as well. CoreWeave's stock experienced further declines on Thursday, compounding the 15.5% drop from the previous day. Other neocloud stocks similarly faced declines, with Nebius down 5% and Iren falling 8% in Thursday's trading session.

Fears over AI spending mismanagement are also impacting other industry players. Notably, shares of Micron Technology and Advanced Micro Devices fell by 4% and 6%, respectively, following a significant sell-off in South Korea's semiconductor sector.

Despite a continuous rise in anxiety about AI-related debt, investor sentiment has turned increasingly cautious regarding the financial fundamentals of companies that rely heavily on borrowing for chip acquisition, data center construction, and the leasing of computing resources.

Credit default swaps serve as contracts where investors pay for protection in scenarios where borrowers are unable to meet their debt obligations. The widening of CoreWeave's CDS spread signifies that investors are increasingly viewing its debt as high-risk.

According to the Evercore ISI trading desk, the market is essentially signaling a strong aversion to AI debt lacking supportive operating cash flows.

Typically, a CDS spread of 1,000 basis points or more indicates credit distress, remarked Gavan Nolan, executive director of fixed income pricing at S&P Global Market Intelligence.

There are no doubts regarding the demand for CoreWeave's services, as it maintains contracts with major hyperscalers. However, the crucial question is whether adequate cash flows will materialize in the future.

"The negative free cash flow situation is pronounced at the moment; it is essential for that cash flow to materialize to validate the substantial capital expenditure being undertaken," Nolan stated.

'Self-fulfilling prophecy'

In response to the market volatility, CEO Mike Intrator expressed confidence in a memo obtained by CNBC, downplaying recent fluctuations.

"When establishing a new technological venture, periodic market misunderstandings and irrationality are unavoidable," he remarked. "We remain assured about our backlog, which more than adequately secures all our debt obligations."

CoreWeave's backlog exceeds $100 billion, with approximately two-thirds of this revenue tied to investment-grade partners like Microsoft, Meta, IBM, and Caterpillar, as noted by Deutsche Bank in a Thursday report. The bank reiterated its buy rating for the stock, viewing the current dislocation as a potential buying opportunity.

However, Jim Reid, global head of macro and thematic research, cautioned that such concerns could evolve into a self-fulfilling prophecy, possibly triggering wider issues across other companies associated with AI.

There are indications that a domino effect may already be underway. Oracle's five-year CDS spread also experienced a spike this week, reaching 288 basis points—a more than 12% increase within just one week.

"A downgrade from its BBB rating could compel investment-grade-only fund managers to engage in forced selling," Reid warned.