PIMCO's Highest Conviction Themes in Asset-Based Lending

Angela Shiu: My name is Angela Shiu, and with me I have Kyle McCarthy, a private credit specialist at PIMCO and an expert in asset-based lending. Today, we hope to discuss the specific opportunity set that we are seeing within asset-based lending.

So, my understanding of ABL, the universe is very broad and it's a highly diversified credit market financing many aspects of our global economies. Where are PIMCO's highest conviction ideas and sectors now?

Kyle McCarthy: We like a lot of different sectors today because of that bank retrenchment theme. But if I could summarize into three big picture themes, it's consumer-oriented credit, aviation finance, and digital infrastructure. So, I'll hit on each of them very briefly.

On the consumer side, the U.S. consumer in particular has been very resilient, despite the fact that the Fed has increased rates pretty rapidly over the past couple of years.

Now GDP has grown pretty consistently over a number of years. We've seen consumer balances also increase. But the health of the consumer balance sheet, especially the higher quality end of the spectrum, has actually remained quite healthy. So, our focus is predominantly on higher quality consumers.

And again, I think a lot of that is driven by the fact that they've been largely shielded from rising rates because of the 30-year fixed rate mortgage in the U.S.

Higher quality consumers tend to also be homeowners. So that's a big reason why there they've been so resilient over time. This is a space that, in order to focus on the higher quality borrowers, you really have to lean into large data sets and analytics to understand and assess the risk, but also to underwrite the credits very conservatively.

So that's a big area of focus for us, I'd say, consumer credit, broadly.

In terms of aviation finance, it's largely a story of supply and demand imbalance. On the demand side, you've seen a significant shift in the industry towards leasing aircraft as opposed to owning. So many airlines today, I'd say if you look at the global fleet, over 50% is actually leased as opposed to owned.

So there's significant demand to rent aircraft. You've also seen air traffic, foot traffic, pick up and recover post-COVID. You've seen that globally, but there are even certain markets like China, where it hasn't fully recovered yet. And so, the demand is continuing to pick up. We expect that trend to continue going forward. So, the demand for new aircraft is quite healthy.

The issue is the supply side, where because of COVID, you've had production delays, manufacturing delays, supply chain issues. That has pushed back a lot of the new aircraft coming online and that has created a five, seven, 10-year issue on the supply side. So, you have high demand, very limited supply, it's pushing up lease rates, and we think this is going to be a many-year opportunity set in the tens of billions of dollars in the years to come.

So quite excited about that as well.

On the digital infrastructure side, last but not least, again, this is an area where you've seen greater connectivity, you've seen a huge uptick in AI adoption as well, and of course cloud adoption. And we think it's going to be a trillion-dollar-plus-type investment opportunity or investments required in the coming years. Some of it will be equity, but a lot of it will be financed and, again, financed outside of the traditional banking system.

So, this is a huge opportunity for private lenders such as ourselves, especially in areas like chip finance, for example, so GPUs, CPUs, as well as data center development, which, again, are going to require significant financing needs as we look ahead.

Angela Shiu: Super interesting. Can you give us maybe one investment case study in one of the three sectors that you've highlighted?

Kyle McCarthy: Sure. So, if I stay on the last theme of digital infrastructure, a recent deal included a senior asset-backed loan to a company that provides compute services. So, basically they source chips and build out CPUs and GPUs, and sell those in long-term contracts to some of the largest technology companies in the world.

So, very high quality credits. We like the contractual nature of the revenue streams, and what really makes this loan more of an ABL loan as opposed to just a normal corporate loan, is that the loan itself is secured by the chips.

So, the underwrite is not just a cash flow underwrite of the business, but it's of the value of the chips themselves. So, the loan-to-value is relative to the chip value. In addition, we've also tied the senior loan to the revenue contracts. So, as revenue is actually paid over time, the loans de-risk and are actually paid down.

So, we like that kind of de-risking profile as we go along. So again, senior loan, backed by hard assets, and offers, in our view, a relatively attractive coupon as well.

Angela Shiu: Super interesting, Kyle, and thank you so much for sharing that example with us. I know we have many more to share with our clients and investors. If you would like to find out more, please do not hesitate to reach out to us. Thank you for joining us.