Mounting fears that CoreWeave's debt stress may signal a broader problem with the insatiable borrowing-driven artificial intelligence infrastructure build-out slammed tech stocks this week. The Nasdaq logged a weekly loss of 4.5%. CoreWeave stock plunged nearly 12% on Friday. Shares of the neocloud declined every day except Thursday, losing a quarter of their value since last Friday's close.
Perhaps even more concerning than the stock rout has been the jump in CoreWeave corporate bond yields and spike in credit default swaps, a kind of insurance policy on debt. Corporate credit quality is getting a lot of attention these days, as funding costs increase due to above-target inflation that just won't quit and investor worries about the level of financial commitment being made by companies that don't want to be left behind in the AI race. While the focus is often on stock performance, the corporate bond market offers crucial insights. Credit default swaps (CDS) provide a more complete understanding of credit risk.
If CDS sound familiar, it might be due to the movie "The Big Short," which highlighted their role in the 2008 financial crisis. Hedge-fund manager Michael Burry famously used them to bet against the U.S. housing industry. This week, the yield on a CoreWeave 2031 bond neared 16%, a significant jump from its 9.75% issuance yield in April. Concurrently, five-year CoreWeave CDS exceeded 1,000 basis points, a nearly 19% increase for the week and a staggering 178% higher than a year ago. This trading activity implies a roughly 60% chance of a CoreWeave default within the next five years, according to Bloomberg.
Understanding Credit Default Swaps
A credit default swap acts as insurance against losses from an issuer's default. The premium paid is tied to the value and perceived risk of the debt. While bond yields are influenced by various factors like inflation and risk-free rates (the 10-year Treasury yield is currently near 5.1%), CDS specifically reflect credit risk. This makes them a more transparent gauge of investor sentiment towards a particular debt issuer.
For instance, insuring $1 million in debt with a CDS quote of 100 basis points would cost $10,000 annually. Notably, one doesn't need to own the debt to buy a CDS; they can also be used to speculate on credit quality changes. At 1,000 basis points for CoreWeave, the cost to insure $1 million in debt rises above $100,000 annually.
Why Stock Investors Should Care About CDS
The cost of insurance, much like CDS premiums, is determined by the item's value and the risk associated with insuring it. For stock investors, the perceived risk of default, reflected in rising CDS prices, is paramount. An increase in this perceived risk can be a leading indicator of potential trouble, often impacting equity value long before an actual default occurs.
These debt-related worries are central to CoreWeave's stock performance, which has been significantly impacted despite Nvidia CEO Jensen Huang's assurances. Huang stated on Thursday that CoreWeave's financial position is stable and "improving every day," and that Nvidia does not need to backstop the company because its "cost of capital is actually decreasing." These comments helped reverse earlier losses for CoreWeave on Thursday.
CDS rates, or more importantly, the movement in these rates, offer a quick snapshot of bond investors' sentiment. While not an official credit rating, their frequent pricing provides valuable, real-time data for stock investors seeking to understand market dynamics and individual security performance. Similar to assessing the risk of a beachfront property by looking beyond the listing price to insurance rates, CDS movements can signal underlying credit concerns that might not be immediately apparent in stock prices.
The Bottom Line
As the AI trade evolves, paying attention to the credit default swap market is crucial. For stock investors, the key takeaway is that rising CDS premiums indicate increasing perceived default risk, which can significantly impact equity values. While the intricacies can seem daunting, understanding the trend in CDS pricing offers a valuable lens through which to view potential risks in the broader market.
