An AI label alone no longer wins lenders, JPMorgan says

An AI label alone doesn't secure funding as lenders now weigh a firm’s business and financial viability, according to JPMorgan.

“The AI label alone is no longer enough to reassure lenders. Companies must show that they can finance investment, service their debt and eventually turn spending into cash flow,” Justin Biemann, global investment strategist at J.P. Morgan Private Bank, said in a report published Oct. 23.

Elon Musk issued a similar warning on Sunday, saying debt funding is drying up for AI neoclouds, firms whose revenue depends almost entirely on data centers.

That matters for crypto. AI has been one of the most potent narratives driving risk-taking across financial markets, bitcoin included. Bitcoin and Nvidia both bottomed within weeks of ChatGPT’s debut in late 2022 and have rallied significantly since. Instability in AI could therefore spill over into crypto.

These warnings come as markets grow uneasy over whether AI’s promise will show up on balance sheets. The tech-heavy Nasdaq has slid 6.7% to 29,263 from 31,360 since Oct. 6, with AI-linked firms such as Nvidia and Oracle falling more than the index.

The stress is showing up in credit markets too. The cost of insuring against defaults on the debt of several AI-linked firms has hit record levels. This insurance is called a credit default swap (CDS). The buyer pays a yearly premium, and if the borrower goes bankrupt or fails to pay, the buyer gets a large payout. The premium, also known as the spread, is quoted in basis points. At 100 basis points, insuring $10 million of debt costs $100,000 a year. A wider spread means investors want more compensation to take on the credit risk.

The scramble for CDS shows in volumes too. According to Morgan Stanley, weekly trading in CDS linked to bonds issued by Oracle (ORCL), SpaceX, Alphabet, Amazon, Meta (META), Broadcom and Nvidia (NVDA) averaged more than $9 billion in September, up significantly from under $2 billion a week in July.

The picture is particularly worrying for the most debt-dependent firms. Without naming it, Biemann said one financing-dependent AI infrastructure company has taken on tens of billions of dollars in debt and other obligations. Its five-year CDS jumped to 1,100 basis points, so insuring $10 million of its debt would cost more than $1 million a year.

“Pricing at these levels implies near or above a 50% probability of default over five years, up from below 30% a year ago,” Biemann wrote.

Biemann pointed to Lehman Brothers as an example of CDS working as an early warning. Lehman’s CDS averaged less than 100 basis points in the third quarter of 2007 and topped 1,400 by mid-September 2008, when it filed for bankruptcy and rocked global markets.

Biemann said investors can view CDS today “as warning lights rather than countdown clocks.”

In other words, AI firms aren’t necessarily headed the Lehman way. Besides, activity in CDS tied to the large AI leaders looks more like hedging than positioning for a crisis.

Large AI leaders with strong cash flow pay 50 to 120 basis points for five-year protection, Biemann said. He said these levels “still look more like the price of portfolio insurance than a prediction of financial distress.”

Some established infrastructure borrowers have climbed toward 300 basis points. Protection on the broad investment grade market remains comparatively contained. “The concern is confined to business models that require debt markets to remain open while spending stays high and cash flow remains limited,” he said.