Exclusive-Weinstein's Saba sells credit derivatives on Big Tech as AI risks g...

Hedging Against AI-Driven Debt Risks

By Nell Mackenzie and Lucy Raitano

Demand for Credit Derivatives

LONDON (Reuters) -Boaz Weinstein's Saba Capital Management has sold credit derivatives in recent months to lenders seeking protection on big tech names like Oracle and Microsoft due to concerns over a debt-financed AI investment frenzy, a source told Reuters. Banks have sought to shield their exposure to potential losses by buying credit default swaps (CDS) from the U.S. hedge fund manager, known for his winning bet against the JPMorgan Chase trader dubbed the "London Whale", the person said.

Current Market Conditions

While the credit insurance rises in value in tandem with the perceived risk of a company's default, current prices indicate those risks are still low compared to other sectors.

Impact on Big Tech Companies

Saba sold banks CDSs on Oracle, Microsoft, Meta, Amazon and Google parent Alphabet, said the source, who had direct knowledge of the deals. 

Some large asset managers, including a private credit fund, were also keen to buy the product, the source said.

Microsoft declined to comment. Meta, Google, Amazon and Oracle did not immediately respond to requests for comment.

BANKS SEEK PROTECTION AS TECH FIRMS RACK UP DEBT

The development highlights a scramble to hedge against an explosion in the value of AI companies and their growing debt burdens. It also points to fears that, if the current AI enthusiasm proves to be a bubble, any pop would echo across equity markets as a sharp correction, denting the economy.

The person said it was the first time Saba has sold hedging protection on some of the companies and the first time banks had asked for this kind of trade from the hedge fund.

The finance firms, the source said, were seeking protection against the debt accumulating on companies' balance sheets as they borrow heavily to fund their multi-billion-dollar AI projects.

Equity derivatives trading also saw increased client demand for hedging protection against the sector, a Goldman Sachs client note released on Friday showed.

"Some of this is concern about AI corporate bond supply over the next few quarters after a surprise surge in recent weeks," Deutsche Bank's Jim Reid said in a note on Monday speaking in general about the tech-related CDS market.

"However, it seems that they are also being used as a general hedge for all sorts of positive AI positions."

RISKS LOW COMPARED TO OTHER SECTORS DESPITE BUBBLE WORRIES

While ultimately CDSs are meant to pay compensation if a company goes bust, the derivatives themselves grow in value as the company's economic health declines.

Oracle and Alphabet CDSs are trading at their highest levels in two years, while data from S&P Global shows such contracts for Meta and Microsoft have jumped in recent weeks. Data for Meta CDSs was only available from late October, according to S&P.

Though CDS contracts for big tech names have surged, analysts note that current levels are lower than those for some investment-grade firms in other sectors.

CDS five-year spreads for Oracle reached over 105 basis points last week, while Alphabet and Amazon traded around 38 bps and Microsoft traded around 34 bps, according to S&P data.

Borrowing by so-called hyperscalers - essentially large AI tech firms – has ballooned in recent weeks. Meta raised $30 billion of debt last month. Oracle raised $18 billion in September. And Google owner Alphabet has also tapped the market.

In fact, more than double the sector's average annual IG bond issuance hit the market in September and October alone, BofA data showed. 

Societe Generale noted on Tuesday, however, that bond yield spreads are still below the aggregate investment-grade credit, while others such as Citi flag the hyperscalers' healthy balance sheets.

In his weekly "flow show" report on Friday, Bank of America chief investment strategist Michael Hartnett said: "Best short is AI hyperscaler corporate bonds."

(Reporting by Nell Mackenzie and Lucy Raitano; Editing by Dhara Ranasinghe, Elisa Martinuzzi and Joe Bavier)