The accelerating AI buildout faces significant headwinds as corporate debt becomes more expensive, with widening credit spreads signaling increased investor caution and default risk. This trend is particularly stressful for heavily indebted ‘neocloud’ companies, but also raises concerns for larger cloud hyperscalers despite some protective circular financing arrangements.
Experts predict further spread widening into 2027, potentially failing to compensate investors for risk, and warn that the substantial use of debt and interconnected financing could lead to a sector-wide bust.
The ambitious buildout of artificial intelligence infrastructure is facing a growing challenge: more expensive corporate debt. Credit spreads for the tech companies at the forefront of AI development are expanding, with expectations for further widening later this year as overall debt levels climb. This trend is set to exert significant pressure on highly leveraged tech infrastructure providers, often dubbed 'neoclouds,' and could also impact larger cloud computing hyperscalers.
Understanding 'credit spread' is key: it's the difference in yield between two bonds with the same maturity but varying credit quality. A widening spread signals that investors perceive a greater risk of default, demanding a higher return for their investment. This growing investor caution is evident as major players like Google boost their capital expenditure projections for 2026 and 2027, making credit quality an increasing concern.
Torsten Slok, chief economist at Apollo Global Management, highlighted the severity of the situation to CNBC, noting that credit default swaps (CDS) for hyperscalers are widening substantially. He pointed out that Oracle's CDS levels are now comparable to those seen in 2008, indicating that for many, "the trend is certainly not your friend." Mizuho analysts, including Vijay Rakesh, echoed these warnings, specifically flagging concerns about neoclouds, their negative free cash flow, and capital raise challenges. Smaller neoclouds like CoreWeave, with a debt-to-equity ratio of approximately 739 times, Nebius (131), and Applied Digital (172) demonstrate extreme leverage, starkly contrasting with tech giants such as Alphabet (18), Amazon (51), and Microsoft (30).
Experts anticipate credit spreads to continue widening into 2027. Matthew Mish, head of credit strategy at UBS, forecasts spreads to remain rangebound in Q3 before broadening in Q4 and decompressing into 2027, cautioning that credit returns in the latter half of the year are unlikely to adequately compensate investors for the heightened risk. Much of the innovative tech financing, particularly at the industry's frontier, operates outside conventional bond markets, with some even remaining off-balance-sheet. However, increased scrutiny is expected as the AI computing boom persists.
Amanda Lynam, chief credit strategist at Goldman Sachs, predicted that the multi-year AI investment cycle would necessitate "more nuanced decisions around exposure and pricing." She envisions a diverse array of financing markets—including syndicated credit, private markets, joint ventures, and international capital—being required to meet the substantial funding needs. Recent bond issuances from companies like Nvidia, SpaceX, and Amazon have already tested debt markets, with some struggling and others securing less favorable rates.
The concept of 'circular financing' within the tech sector, such as Nvidia's backstopping agreements for its neocloud clients, presents a double-edged sword. While it can offer some insulation against rising debt costs, it also introduces systemic risks. Jay Goldberg, an analyst at Seaport, noted that neoclouds are already struggling with investment financing, pushing Nvidia to become more directly involved. Similarly, neoclouds like CoreWeave have leveraged the credit ratings of their hyperscaler customers for project-specific debt, as highlighted by Paul Meeks of Freedom Capital Markets, offering a degree of protection.
However, the broader cloud computing sector lacks such widespread safeguards. The Bank for International Settlements (BIS) recently issued a stark warning: extensive use of debt in circular financing could precipitate a market bust. Phurichai Rungcharoenkitkul of BIS pointed to a potential 1.5 times overinvestment and the risk of stress in one firm cascading through interconnected financial exposures. This blend of overinvestment and a complex mix of competition and mutual investment at the frontier is causing considerable apprehension among investors. Dan Alpert, founding partner of Westwood Capital, voiced his primary concern as the credit quality of these companies competing in an intensely intertwined landscape.
