Deutsche Bank anticipates a crash - Begins shorting Artificial Intelligence stocks, fears also about data center debts

For those with a presence in the markets, the memory of the era when Deutsche Bank's sales and trading desks quietly offered CDS to clients to hedge against the probability of a real estate/mortgage crisis or a total collapse of the global financial system is still vivid. After all, the reference film, The Big Short, even featured the Deutsche Bank man, Greg Lippmann, the real bond trader, as Jared Vennett.

Lippmann worked at Deutsche Bank and was instrumental in creating the enormous CDS market, which allowed investors to bet against the real estate market before the 2008 financial crisis.

But what happened to make everyone remember this film?

Deutsche Bank's gamble

According to the Financial Times, Deutsche Bank appears to be exploring ways to hedge its exposure to data centers after granting multi-billion dollar loans to this sector to meet the demand for Artificial Intelligence and cloud computing. Internal bank executives have discussed ways to manage their exposure to the rapidly growing sector, as the so-called hyperscalers invest hundreds of billions of dollars in building infrastructure for AI needs, increasingly financed by debt. The German bank is considering options such as shorting an index of AI-related stocks, which could help offset market risk by betting against companies in the sector. It is also considering buying debt default protection for some of the loans using derivatives through a transaction known as synthetic risk transfer (SRT).

What is happening with data centers

If Deutsche Bank was so confident in the "beneficial" nature of the capital expenditures for data centers, which have been repeatedly highlighted, why would it feel the need to hedge this risk?

It's not exactly a fair question, since hedging is something everyone does to some extent, but it still raises questions—questions that many outside Wall Street have also raised when exposed to the multipliers and financing cycles that keep the dream alive in the world of AI. Deutsche Bank's investment banking unit has "bet heavily" on data center financing, according to a senior bank executive.

Essentially, Deutsche Bank has lent mainly to businesses that serve the hyperscalers, such as Alphabet, Microsoft, and Amazon, and the loans are secured by long-term contracts that promise stable returns. In recent months, Deutsche has provided debt financing to Sweden's EcoDataCenter and Canada's 5C, which together raised over $1 billion to boost their expansion. The investment bank does not disclose the exact amount it has lent to the sector, but it is estimated to be billions of dollars.

The structure of SRTs

It is worth noting here that TMT IG credit has dramatically decoupled from TMT equity, with the latter confirmed by the recent pricing of Google, Meta, and Oracle stocks relative to their credit worthiness. The structure of the SRT that Deutsche Bank is reportedly considering closely resembles the old CDOs—a diversified pool of loans (in this case AI-Capex financing loans instead of home loans) that are bundled and then mathematically broken down into "tranches," capable of misleading rating agencies and securing good credit ratings. To recall, the correlation assumptions (mathematics) behind these ratings and structures did not end well for the final buyer.

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