Our Chief Fixed Income Strategist Vishy Tirupattur brings in
Vishwas Patkar, Head of U.S. Credit Strategy, and Carolyn
Campbell, Head of Consumer and Commercial ABS Research, to
explain our high conviction on the role of credit markets in data
center financing.
Read more insights from Morgan Stanley.
----- Transcript -----
Vishy Tirupattur: Welcome to Thoughts on
the Market. I am Vishy Tirupattur, Morgan Stanley’s Chief Fixed
Income Strategist.
Vishwas Patkar: I'm Vishwas Patkar, Head of
U.S. Credit Strategy.
Carolyn Campbell: And I'm Carolyn Campbell,
Head of Consumer and Commercial ABS Research.
Vishy Tirupattur: Today we'll talk about
the feedback – and pushback – we've received on the data center
financing note we wrote a few weeks ago.
It's Tuesday, August 19th at 10am In New York.
In the week since we published a report on bridging the data
center financing gap, we were met with a wide range of investors
to discuss the key takeaways from our report.
We projected that meeting the data center demand requires
something like $3 trillion of capital expenditure by 2028. And we
projected that about half of this funding will come from
hyperscaler cash flows, but the rest financed through different
channels of the credit markets.
So, Vishwas, some of the skeptics invoke comparisons to prior
CapEx cycles, particularly the late 1990s telecom boom that did
not quite end well. How would you respond to that
skepticism?
Vishwas Patkar: The 1990s telecom CapEx
cycle certainly came up in a lot of our meetings. It was the last
time we arguably saw CapEx cycle of this magnitude. I think the
counter to this is that there are some very important differences
versus what we saw then versus what we expect. Most importantly,
the CapEx cycle back then was largely financed on corporate
balance sheets, and we saw pretty significant uptake in debt
issuance and leverage.
Also, through the 1990s, the names, the companies that were
spending were mid- to low-credit quality and not cash rich.
That's very different from the hyperscalers that are in the
center of the AI spending. And these companies are very cash
rich, and their credit ratings range all the way from AAA to high
A. So very much at the top end of the spectrum.
In addition, we are quite optimistic about AI monetization, both
the timeline and the magnitude. Some of this has also already
been validated through second quarter earnings. We also think
financing will be done through multiple channels going forward
and it won't largely flow through to corporate debt. In fact,
corporate debt issuance is actually a pretty small number of how
we think this [$]3 trillion number will be met. And you know, the
private credit piece, that we have talked about a lot in this
report; we think it's likely to be skewed towards IG ratings, in
many cases backed by contractual cash flows from credit worthy
tenants.
So, the risk, in some ways, could come from the sub investment
grade non-hyperscaler type tenants. And that's an important theme
to be watching. But by and large, this cycle is very different in
our view from the late 1990s.
Vishy Tirupattur: So, Carolyn, another
pushback, is that the market will be overbuilt and won't be able
to refinance in say, five years…
Carolyn Campbell: Yeah, Vishy. This is a
really big concern, particularly for securitized credit
investors. We're starting to see some of the ABS and CMBS deals
look to refinance even this year, and that will pick up as time
goes on and these deals hit their five-year maturities.
However, the biggest challenge to building new data centers in
the U.S. today is access to power. Our equity research colleagues
have identified a 45-gigawatt power bottleneck in the U.S., and
we think this should keep the market structurally undersupplied
of power and slow down the pace of construction, really limiting
that overbuild risk. Thus, we expect that the churn and the
vacancy rates will actually remain quite low in the medium
term.
And so, while it's a concern that in the long run that these data
centers will decline in value; for now we don't see that to be a
primary concern.
Vishy Tirupattur: Carolyn, another concern
we heard is that the investor demand will not keep pace with the
supply, particularly in securitized credit. We also heard about
the tenant quality, that tenant quality is a major concern in
underwriting these deals.
So how would you respond to those two points?
Carolyn Campbell: Right. I mean, within ABS
and CMBS, we don't think supply is really the limiting factor. We
think it will come on the demand side for why we think that this
market will grow to about [$]150 billion by 2028.
However, our discussions with investors and the data that we've
seen suggest that while there are a few big accounts that have
been active in the ABS and CMBS space so far, many have yet to
allocate meaningfully – preferring perhaps even other esoterics
so far. And so, we think that as the supply grows, so too will
the number of accounts and the size within which they're
participating.
That being said, the market is already starting to price in a
higher risk of tenant weakness. We started to see deals with a
lower proportion of IG or greater exposure to AI names price
meaningfully wider than those deals that are almost entirely IG
and are more for collocation and enterprise.
Ultimately there will be winners and losers in this new AI
industry. And so, the diversification across region and across
tenant type, exposure to residual cloud and enterprise
businesses, and the proportion of IG and non-AI tenants in these
deals will be very important as we assess the risks of ABS and
CMBS deals.
Vishy Tirupattur: Vishwas, any way we cut
it, the scale of investment here is pretty large. Would this
scale of investment divert capital away from public credit?
Vishwas Patkar: I certainly think that's a
possibility, and maybe even a risk over time – but probably
skewed towards the back half of our forecast horizon, which goes
through 2028. I think with the public credit market, the next few
quarters’ supply should be largely manageable, and demand has
been and should stay quite strong. But if you look a few quarters
out, insurance demand has been very critical to what's supporting
credit markets right now. If interest rates go lower, some of
these insurance inflows could slow down.
And we've also talked about insurance allocations that are
shifting towards private and securitized credit at the expense of
corporate credit. So, slowly, you could say supply needs rise.
You know, we have about [$]800 billion of financing that needs to
be met by private credit while inflow slow down. So, I wouldn't
view this as a fundamental risk for public credit, but certainly
a reason why credit spreads may not stay as tight as they are,
over a period of time.
Vishy Tirupattur: So ultimately, our
projections are based on the transformative potential for AI and
the role of data center financing to enable that. This is a high
conviction view. As we have said elsewhere, we are not too wedded
to the specific size estimates in the broad constellation of
financing channels.
The point we want to drive home here is that credit markets will
play a major role in enabling AI driven technology fusion. As
always, they will be winners and losers, but data center
financing as a theme for credit investors is here to stay.
Thanks for listening. If you enjoy the show, leave us a review
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