The Federal Reserve is closely monitoring leverage in the rapid data center build-out, noting that in the event of a downturn in artificial intelligence, the defaults on debt could be larger than current balance sheets suggest, according to a report on financial stability released Friday.
Initially, hyperscalers self-funded data centers, with debt issuance having risen to more than $680 billion as of October — a fivefold increase from $130 billion in all of 2023. But now the composition of the debt being issued is evolving from mostly corporate bonds to a combination of public and private debt and structured credit.
In addition, large technology firms are rapidly increasing future lease commitments, backstop guarantees provided to other firms, and other complex and contingent obligations.
A dynamic of circular financing is taking hold that echoes the 2008 financial crisis in which there was mounting debt off firms’ balance sheets. The evidence suggests AI firms’ economic exposure in the event of a downturn could be larger than their current balance sheets would suggest.
Hyperscaler firms often enter into long-term leases for data center capacity with third-party data center developers. These leases are then used by the third-party developers to secure financing for construction. In addition, graphics processing unit (GPU) makers often provide a guaranteed residual value of the GPU collateral to support purchases of their GPUs by advanced computing technology or large language model (LLM) firms. These debt financings that link hyperscalers and GPU designers with smaller firms are often supplemented by equity investments from the hyperscalers and GPU designers, creating a “circular financing” dynamic.
That’s deepening the connection between large hyperscalers and smaller, riskier companies with less access to credit.
The Fed estimates future leases and backstop guarantees for data center build-outs are about $3 trillion now. It says cash outflows for capital expenditures suggest that the pace of the current cycle’s investment may surpass that of the 1990s telecom cycle relatively soon.
At the same time, asset valuations across asset classes, from stocks to corporate bonds and real estate, are elevated, and hedge funds have the most leverage since 2013.
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Source: finance.yahoo.com
