Wall Street banks trade more credit derivatives as hyperscalers borrow heavily for AI, creating hedge fund profit opportunity

Hyperscalers such as Meta Platforms Inc. and Alphabet Inc. have borrowed more than $250 billion globally for AI, pushing banks toward their exposure limits on single companies across loan portfolios and derivatives books.

Banks use credit derivatives (instruments that provide protection against a company defaulting on debt) to reduce exposure to borrowers, freeing capacity to lend more, underwrite debt, and trade derivatives with them.

Hedge funds are selling protection on hyperscaler credit default swaps at prices that appear overpriced relative to credit quality. Meta five-year credit default swap contracts traded at about 0.73 percentage point annually on Friday (meaning $73,000 annually per $10 million of principal), compared with about $52,000 for the North American investment-grade index average, despite Meta being rated AA- by S&P Global Ratings and Aa3 by Moody's Ratings (the fourth-highest level).