Economic and Market Commentary

Exploring the trends and opportunities in private credit today

Alternative Credit Strategist Kyle McCarthy shares PIMCO’s latest views on private credit markets across residential and commercial real estate, corporate credit and specialty finance.

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Text on screen: John Valtwies, Account Manager

Valtwies: Welcome to our latest private credit quarterly update.

Kyle, we’re receiving a lot more interest in private credit today. Can you distil for us what's going on in private credit right now? And perhaps also just level set once again, exactly how PIMCO views private credit.

Text on screen: Kyle McCarthy, Alternative Credit Strategist

McCarthy: Thanks, John. Great to be here.

High level how PIMCO approaches private credit is very much through the fixed income lens based on our DNA. We define the space very broadly, more of a multi-sector approach. So, we're investing across the entire landscape of private credit. That includes private corporate lending, residential mortgage credit, commercial real estate lending and specialty finance, things like consumer credit or aviation finance.

What we're observing today in terms of big picture trends in the market is a really interesting divergence, if you will, in terms of the competitive landscape. On one end, you have private corporate lending that I would say is quite competitive now. And on the other end, you have asset-based finance or specialty finance, areas where the banks are still pulling back in a pretty material way.

What's interesting on the corporate side is that it's a reversal of a trend that we've been seeing over the past two years, which is private lenders taking market share from the banks. Now the banks are back and are trying to recapture that market share.

We've seen a lot of bank loan issuance. The CLO engine has been turned back on again as well. And what's happening is that's compressing the terms that you can get in terms of coupons. So that's where we're seeing the most competition today. And it is compressing yields somewhat.

The good news is from a risk perspective, because of the high cost of debt, we're not seeing a lot of corporate borrowers looking to lever up balance sheets significantly. So, from a risk perspective, though, new origination is still quite attractive. Although again, there's more competition on pricing in our view.

On the asset-based lending side, again, it’s the complete opposite. Given the regional bank turmoil that we saw in the U.S. last year, with regulators stepping in, banks are retrenching in a pretty major way across all forms of specialty finance, asset-based lending.

So, think consumer credit, think non-core businesses, anything insurance related, aviation finance. Banks are looking to do less of that. And so they're selling assets off of the balance sheet and they're also looking for partners like ourselves that they can originate and sell to.

So, it's a very interesting divergence at the moment in terms of the competitive landscape for the corporate space versus other forms of asset-based private credit.

Valtwies: Kyle, that's a helpful backdrop on the corporate sector. Perhaps it's worthwhile going a little bit deeper into specialty finance. You touched on the impact from the regional banks pulling back in some of those sectors in the U.S.. Can you talk in a little bit more detail about what we're seeing in those specialty finance sectors?

McCarthy: Yes, happy to go a little bit more detailed into each of the sectors.

We talked about the competitive dynamics right now within the corporate lending space. But again, in more of the asset-based lending areas, we're seeing much better value.

So, if we start with residential mortgage credit, this is an area that we like a lot. Yields are still quite attractive. Mortgage rates are still quite high. And what we really like about it is the safety that's built into the structures themselves. These are senior secured mortgages. We have a first lien on the underlying property. These are backed by single family homes. And it leans on this broader theme of the resilience of the U.S. consumer, which still remains one of our higher conviction views. So, we like that space a lot.

More broadly in specialty finance again, consumer credit. I just hit on the theme in terms of the resilience of the U.S. economy and the U.S. consumer. We like all forms of consumer credit, but in the up in quality, kind of higher credit worthy borrowers.

And then outside of the consumer space or in the commercial asset-backed side of things, think aviation finance, that is one of our highest conviction views today. A good example of a hard asset-backed lending opportunity where we're leasing out an airplane to an airline and receiving contractual cash flows over time, that market has significant supply/demand imbalances right now, with new production orders, backlogs of 5 to 7 years into the future.

So, we think it's an opportunity that's going to remain for quite some time, providing us with an opportunity to lease these planes at very attractive lease rates.

Outside of the residential and consumer space, if we just touch on commercial real estate very quickly, there we're seeing still a lot of dispersion across property types. So we're quite cautious. We're picking our spots carefully. Obviously, a lot of headlines on office and the challenges with work from home, but in more of the digital economy sectors. So, think things like logistics or industrial or data centres. We're finding significant opportunities there with a lot of growth, need for more developments, and rental growth as well. So overall, trying to be very selective in terms of opportunities within commercial real estate specifically.

But again, another good example of an area where the regional banks in particular have very bloated balance sheets with commercial real estate loans, and it's an area that they're pulling back in a material way, allowing private lenders like ourselves to step in and fill that void.

So bottom line, a lot of opportunities across the asset-based lending space today, whether it's residential credit, whether it's other forms of specialty finance like aviation, commercial real estate, we think it’s an opportunity set that will be building over the next 12 to 18 months.

But overall, quite excited about the yields and the risk profiles that we're seeing right now.

Valtwies: Well thanks, Kyle. In this environment of elevated interest rates, we feel that the benefits of private credit certainly remain. Those include structural seniority, a focus on resilient income and importantly, the diversity across multiple sectors within private credit markets.

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