Fears over artificial intelligence debt have eased after a bout of volatility. But more tests for AI debt are coming.
Oracle holds its Investor Day on Wednesday. And hyperscalers Alphabet and Amazon.com are scheduled to report quarterly results after the market close on Wednesday and Thursday, respectively.
Credit markets are on edge over a flood of AI debt, though fears have eased up a little lately. Meta Platforms' plans for a $95 billion stock offering, announced on Monday, helped bring down its credit-default swap spreads. Those spreads had risen last week when the company reported negative free cash flow in the third quarter. Other CDS spreads had moved higher too, though they have since backed off.
Investors had expected Meta to bring a large bond deal to market shortly after its earnings announcement, said Richard Cheng, head of Nuveen's investment-grade corporate sector team. The fact that it wasn't announced came as a relief.
"Just the absence of the bond deal itself is a direct catalyst for AI-related spread tightening," he said.
A credit spread is the difference in the yield between the corporate bonds and Treasurys of similar maturities. When spreads tighten, it means investors are becoming more confident about the bond issuer.
Fears 'overblown'
The market action over the last few days shows that investors are recognizing that "credit fears may have been overblown," said CNBC contributor Paul Meeks, head of technology research at Freedom Capital Markets.
"I expect that these better feelings, maybe not good but better, may continue as companies announce their quarters over the next few weeks."
Still, spreads on CDS remain wider over the past year due to a surge of debt issuance and free cash flows turning negative across the AI space. Meta's CDS spread, for instance, is still up 177% year to date, while Amazon's spread has gained 129%.
Bond yields also remain elevated.
"It's not necessarily fundamentals," said CreditSights analyst Jordan Chalfin. "It's more, I'd say, 80% driven by technicals and sentiment."
Earnings in focus
Alphabet and Amazon pose the next big hurdle for tech bonds as they update their capex plans and free cash flow forecasts. Microsoft's earnings are also due Wednesday, but the company has yet to issue any bonds to pay for its AI spending.
Both Amazon and Alphabet reported negative free cash flow in the second quarter and analysts expect that trend to have continue.
Analysts expect Alphabet to report free cash flow of -$2.3 billion while spending $55.2 billion on capital expenditures in the third quarter, according to FactSet consensus estimates. Amazon is expected to report -$9.9 billion in free cash flow against capex of $58.7 billion.
S&P Global Ratings estimated in an August report that the hyperscalers will have negative free operating cash flow in 2026 and 2027.
More critical will be their outlooks, Cheng says. "The singular focus on the investors' minds is really what the capex guidance trajectory looks like across the hyperscaler space."
Meeks believes elevated capex is a sign of strong AI demand. The hyperscalers have "decided that with all the evidence they have — and they have more than you and me — that this is worthwhile spending, and not just worthwhile; it's required," he said.
CreditSights' Chalfin doesn't expect the hyperscalers to announce major new bond issuance around their earnings reports. Oracle's updates may be more critical for credit markets. The company has issued $117 billion in long-term debt and is clinging to an investment-grade credit rating of BBB-1, the lowest level of investment grade above junk, according to S&P.
"It's the most important IG tech credit, just given how it's a bit more stressed relative to the A-rated names," he said. "It's trading more like a high-yield credit, even though it's IG, and so there's just a lot of investor concern on that one."
Off-balance sheet debt
One wrinkle to the AI debt story: balance sheets don't reveal the whole picture. The companies are using complicated off-balance sheet arrangements for data centers and chip financing, and they aren't fully transparent, S&P Global said in a September report.
"There are commitments they are entering into, for example, into data center leases or purchase commitments on chips that aren't necessarily treated as debt," Mark Habib, digital infrastructure sector lead at S&P Global Ratings, said on CNBC's "Squawk on the Street" Monday.
S&P is trying to provide the market with more visibility on those commitments "to give a fuller picture of what kinds of obligations they're actually entering into," he added.
Oracle aside, hyperscaler credit ratings are all comfortably above A levels — reflecting the fact that they have broadly diversified revenue streams, ample coverage for interest payments, and capacity to add leverage if they choose.
Nuveen's Cheng isn't concerned, pointing out that while there has been some credit repricing, there is no credit crisis.
"They continue to have exceptional credit profiles, strong cash generation liquidity," he said of the largest hyperscalers.
"The market is really not concerned about credit quality at this point," Cheng added. "It's really just the trajectory of the capex needs and the supply of debt to fund that. Both of those are pointing in one direction — and that's up."