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In Wednesday’s MainFT, the AI funding quote to end all AI funding quotes:
(The capital of insurers) is unlimited. All the money in the world is in the insurance bracket.
It was Brannin McBee, co-founder of CoreWeave, who discovered that if one could simply find a way to assign an investment-grade rating to some form of debt – whether it was senior unsecured government bonds, widely syndicated loans, direct loans, or private credit financings based on weird and wacky chip-backed assets – the universe of potential financiers opens up a lot.
And judging by the way CoreWeave’s debt is trading, opening up the universe of potential financiers seems to be a topic McBee is rightly focused on:
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Definitions vary as to what constitutes “distressed debt”, but a common definition is where investors demand additional yield beyond the yield available to them by holding government bonds of more than 1,000 basis points. By this definition, CoreWeave’s debt now trades in distress.
Additionally, as Finance 101 suggests, the cost of insuring CoreWeave’s debt against a five-year default has increased alongside CoreWeave’s credit spreads. It now amounts to more than 11 percent of the principal per year.
Normally, the buyer of credit default protection pays a regular premium, expressed in basis points, multiplied by the insured amount. So, if the CDS spread was 300 basis points and the notional was $10 million, you would pay $300,000 per year to buy credit protection. At the levels reported on Bloomberg, the cost of insuring $10 million of CoreWeave debt reached $1.1 million per year.
But when spreads become wide enough, CDS tend to be traded “out of the box.” And it appears that CoreWeave has now passed this threshold. Now, the purchaser of the protection must part with a large lump sum up front, then also pay a premium each year.
The rationale for moving to upfront payment is to protect investors selling credit protection from a massive loss in the event of a very short-term default.
For what? Imagine that you are a protection salesman and you expect everything to be fine. You sell protection at 1,117 basis points thinking you’re getting $1.117 million for every $10 million of protection sold. Without an upfront component, you’ll only receive $279,250 four times a year and you won’t even receive the first payment until December. But if a default occurred before then, you would face losses of up to $10 million, without ever receiving a cent for your troubles.
So at pixel time, someone wanting to buy $10 million of CoreWeave default protection has to pay $1.95 million on day one, and then another $125,000 each quarter.
It appears that CoreWeave needs to accelerate its efforts to figure out how to tap into this bottomless pit of insurance capital.
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Further reading:
— Eight Strange Things in CoreWeave’s (FTAV) IPO Prospectus
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