PIMCO Sees Emerging Divide in Junk-Bond Markets for Data Centers

Data Center Debt Market Showcases Winners and Losers

The high-yield debt market for data centers is booming, with Pacific Investment Management Co.'s leveraged finance chief cautioning investors to be aware of the emerging winners and losers in the space. As the market size has grown from zero to 4% in the past year, with expectations of reaching 10% within the next two years, concerns are rising about the underlying stress beneath seemingly calm market conditions.

According to David Forgash, Pimco's leveraged finance chief, 75% of the high-yield debt in the data center market is trading at spreads of 6%, while the remaining 25% is at spreads of 10% or greater. This discrepancy masks the growing stress in the market, where junk-debt borrowing for data centers now represents 2.7% of the US market, part of more than $250 billion in global borrowing by hyperscalers to meet the demand for infrastructure to support artificial intelligence.

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The par value of the US junk debt is approximately $40 billion, with most of it issued within the past year, according to Bloomberg Intelligence. Forgash emphasized that Pimco focuses on investment-grade companies with offtake agreements that cannot be easily terminated, ensuring repayment before contract expiration and residual value remaining afterward.

While software companies represent 15% of leveraged loans, they only account for 3% of high-yield bonds, limiting contagion risks in the latter market. As a result, Pimco has largely avoided software exposure in its actively managed loan products, which have returned more than 6% by selecting among approximately 1,200 loan issuers. The firm sees opportunities in homebuilders and building suppliers, which have sold off despite potential benefits from eventual rate cuts, and maintains an overweight position in energy through year-end.