As market murmurs about an AI bubble, our Head of Corporate
Credit Research Andrew Sheets offers some perspective on the
impacts of the increasing demand for debt.
Read more insights from Morgan Stanley.
----- Transcript -----
Andrew Sheets: 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 6pm in Singapore.
It has 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 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, they shrank and 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 U.S.
saw much tighter lending standards and less overall 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 macro economy, like the eurozone crisis or COVID. Or
they've been driven by companies’ specific issues such as
weakness around the oil sector in the mid 2010s 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 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 two-year
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 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 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 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 AA
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 is a new challenge – something we
haven't encountered for some time. And based on the
aforementioned spending plans, it may be with us for some time to
come.
Thank you as always, for your time. If you find Thoughts on 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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