JPMorgan says AI firms must prove financial viability to secure loans

JPMorgan said lenders now assess AI companies' business and financial viability rather than accept an AI label as sufficient reassurance. Justin Biemann, global investment strategist at J.P. Morgan Private Bank, said companies must demonstrate an ability to fund investment, meet debt payments and ultimately generate cash flow from spending. Biemann made the assessment in a report published Oct. 23. JPMorgan said stress centers on businesses dependent on continued borrowing, but warned that a deeper AI downturn could spread to bitcoin and other risk assets.

Elon Musk warned on Sunday that debt financing is drying up for AI neoclouds, companies that derive almost all revenue from data centers. AI has provided a powerful reason for investors to take risks across financial markets, including bitcoin. Bitcoin and Nvidia reached lows within weeks of ChatGPT's launch in late 2022 and have since risen substantially. Instability in AI could consequently spread to crypto.

Markets have become increasingly concerned about whether AI's promised benefits will translate into financial results. The technology-heavy Nasdaq has fallen 6.7% from 31,360 to 29,263 since Oct. 6. Nvidia and Oracle are among the AI-linked companies whose shares have declined more than the index.

The cost of default insurance on several AI-linked companies' debt has reached record highs. A credit default swap, or CDS, provides a large payout if a borrower goes bankrupt or misses payments, in exchange for an annual premium. The premium, called the spread, is measured in basis points. A spread of 100 basis points means protection on $10 million of debt costs $100,000 annually. Wider spreads indicate that investors demand greater compensation for credit risk. Morgan Stanley said weekly CDS trading linked to bonds from Oracle, SpaceX, Alphabet, Amazon, Meta, Broadcom and Nvidia averaged more than $9 billion in September. Morgan Stanley put the July average at under $2 billion per week.

Biemann said an unnamed AI infrastructure company dependent on financing has accumulated tens of billions of dollars in debt and other commitments. Biemann said the company's five-year CDS spread rose to 1,100 basis points, putting annual protection costs above $1 million for $10 million of debt. Biemann wrote that this pricing implies a five-year default probability near or above 50%, compared with below 30% a year earlier. Biemann cited Lehman Brothers to illustrate how CDS can provide an early warning. Lehman's CDS spread averaged below 100 basis points in the third quarter of 2007. Lehman's spread exceeded 1,400 basis points by mid-September 2008, when Lehman filed for bankruptcy and disrupted global markets.

Biemann said investors should treat current CDS prices "as warning lights rather than countdown clocks." AI companies are not necessarily approaching a collapse like Lehman's. CDS activity involving large AI leaders appears more consistent with hedging than preparation for a crisis. Biemann said large AI leaders with strong cash flow pay 50 to 120 basis points for five-year protection. Biemann said those prices still resemble portfolio insurance costs more than forecasts of financial distress. Some established infrastructure borrowers' spreads have risen toward 300 basis points. Default protection costs across the broader investment-grade market remain relatively contained. Biemann said concern is limited to businesses that need continued debt-market access while expenditure remains high and cash flow stays limited.