AI – complex credit risk

OpenAI complex credit risk

OpenAI, the owner of artificial intelligence (AI) ‘chatbot’ ChatGPT recently entered into talks for a major new round of funding, which is critical to a network of financial arrangements and hardware deals it has built up as it seeks to secure computing power. Technology heavyweights from Nvidia to Oracle rely on contracts with OpenAI for their future revenues. To support growth, OpenAI needs to invest in data centres and computing power to train and run its AI models.

OpenAI is reported to be seeking a valuation of $1.2 trillion, up from $850 billion in March 2026. To support this valuation, it has been forecast in presentations to investors that revenue could grow from $36 billion this year to $840 billion by 2030. However, this will require massive up-front investment and as a result, OpenAI expects negative free cash flow of $278bn over the next five years.

OpenAI is not alone in its ambitious growth and spending plans, and more AI giants are seeking fresh ways to fund growth.

This has led to the growth of residual value guarantee funding by banks, under which the AI giants guarantee a minimum future value for chips or data centres. Bankers describe the guarantees as ‘balance sheet efficient’ or hidden off-balance sheet exposure. This is because the debt is issued by special purpose vehicles that own the infrastructure, rather than the AI companies themselves. This allows them to lend their financial muscle to deals without needing to fully book the liabilities. However, they have to cover specified shortfalls if these AI assets have to be sold one day or fetch less than a guaranteed minimum value.

There has been a significant expansion in off-balance sheet exposure over the past year and $300bn is thought to have been raised by AI companies via residual guarantee funding. Some analysts estimate that off-balance-sheet commitments and credit support by major AI hyper-scalers and chip makers is now in excess of $3 trillion. This has added a very high degree of complexity to the credit risk profiles of these AI businesses. Credit rating agencies and bond investors are warning that this structure could result in substantial losses if AI hardware values were to decline.

AI companies are currently involved in a global race for supremacy. OpenAI has already reduced its prices as it seeks to take market share from US rival Anthropic and has reacted to the threat of cheaper ‘open weight’ AI models from China.

Only time will tell if the use of residual guarantee funding was a wise decision.

 

What have we been watching?

 

US government bond yields are hitting their highest level since 2007 on expectations of higher inflation and interest rates. However, US equities were supported by positive economic data, leaving the S&P 500 index within 1% of its record high. Hopes were also raised by the prospect of US-Iran talks, but this enthusiasm has been dented over the weekend.

Last week saw the summit between Presidents Trump and Xi Jinping. The main news from a market standpoint was that the trade truce is to be extended by a further two months, which will now keep tariffs at a lower level until 10th January. This is shorter than had been signalled by US officials beforehand but does offer more time to potentially reach a longer deal. The two leaders also discussed AI, although it’s unclear whether they agreed to any safeguards.

Iran reiterated that it would not soften the conditions for reopening the Strait of Hormuz. Iran’s foreign minister insisted that it would not back down from demands including sanctions relief, access to its frozen assets and an end to US blockade measures. President Trump rejected Iran’s latest proposal as inadequate but said he expected negotiations to continue. Lines of communication remain open, but that is the only positive, otherwise the US and Iran appear to be in stalemate. This morning, Brent oil has climbed over 2% to almost $107. Iran appears to be holding out in the hope that by prolonging the uncertainty, it can damage Trump in the US mid-term elections on November 3rd.  The US administration is reported to be considering a diesel export ban to lower domestic fuel prices ahead of the midterm elections.

The AI debate continues to impact global equity markets. Over the weekend, OpenAI announced that it was pausing development of certain advanced AI models after agents have been reported to have gone rogue across a number of recent incidents. OpenAI acknowledged that it alerted ‘dozens’ of global institutions after their websites had been meddled with by its AI bots acting improperly. This disclosure comes days after Australia’s PM announced that OpenAI agents had breached non-public files on the website of its government-run health scheme.

 

Read our latest UK investment insights from Alpha PM

 

The UK ‘flash’ PMI business activity indicator dropped to 51.7 from 52.5 last month, with the manufacturing expanding slightly but the service sector contracting ahead of the budget on 28th October. Energy costs, higher borrowing costs and continuing geopolitical uncertainty were cited as adversely impacting company confidence. Meanwhile, government borrowing in August was higher than expected at £18.3 billion taking the year-to-date deficit up to £77.3bn compared with the OBR forecast of £69.3bn!

 

 

The Eurozone ‘flash’ PMI business activity indicator climbed to a 3 year high of 53.1. However, higher inflation and interest rate worries saw the German 10-year Bund yield rise to a post-2009 high of 3.6%.

 

The US ‘flash’ PMI business activity indicator hit a 5-year high of 58.4. Following this data release, the chances of a US interest rate hike by the Federal Reserve in October have climbed from 53% to 64%, according to futures traders. Reflecting these developments and events in the Gulf region, the US 10-year Treasury yield climbed to 5.16%, the highest level since 2007. Meanwhile, the 30-year US Treasury yield almost hit 5.5%, the highest level since 2004. This is having an impact on the US housing market, with the US 30-year mortgage rate now above 7%.

 

The Japanese 10-year bond yield hits its highest level since 1996 moving above 3%.

Finally, Nvidia Chief Executive Jensen Huang has described warnings that AI could lead to humanity’s extinction by the next decade as ‘doomsday narratives.’ He said ‘2030 is not going to be the end of the world.’ Given the amount of money AI hyper-scalers and chip makers are currently spending, let’s hope not, as what a waste of money that would prove to be!

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