ABS
PIMCO has participated in the ABS market since it began, and our approach to investing in the asset class reflects the expertise we have acquired. PIMCO actively trades in student loans, auto, credit card, equipment and other more esoteric asset-backed securities. Analysis of the ABS securities is multi-faceted and is largely sector-specific. Over time, we have developed a unique, comprehensive approach to ABS that combines top-down macroeconomic forecasting with rigorous bottom-up credit analysis. The top-down approach looks to identify macroeconomic trends that will affect the bond markets over the next three to five years, as well as more immediate impact of economic and business cycles. We conduct independent, rigorous bottom-up analysis of every asset-backed security we consider for our investment portfolios, regardless of credit ratings.
This analysis of ABS can be broken down into several steps. First, our ABS specialists look at the collateral supporting the investment to determine its market value. The value of the collateral (as priced in the secondary market) should cover the value of the bonds. Second, our ABS analysts conduct cash flow “stress tests” on the transaction to determine how the loans or receivables will perform under less favorable circumstances and how the payment structure will work under various scenarios. For these tests, we use proprietary delinquency, default and loss curves based on historical patterns for each asset class.
When an ABS appears attractive on the basis of the collateral, the cash flows and the payment structure, we move on to our “validation” process in which we examine market factors and other influences on the transaction. This may include the fundamentals of the industry involved, whether it is the auto industry or the credit card industry, the history of the loan servicer, the risk that an originator will declare bankruptcy and the potential impact on the ABS, and the value of the embedded options in the ABS (e.g., prepayment risk, clean-up calls, interest rate caps, and other derivative-type components that can affect the value of a security).
When analyzing the industry risks as well as risks stemming from the originator, our ABS specialists work with our corporate analysts, and when we value the embedded options in an ABS, our derivatives team contributes using PIMCO’s own models.
Finally, we examine the alignment within the capital structure of the ABS to ensure that as investors, we purchase the optimal securities for our portfolios. For example, we prefer senior class securities and prefer transactions in which as senior note holders, we are paid first rather than those in which we would share principal payments with the investors in the subordinate securities.
PIMCO invests in the entire spectrum of asset-backed securities in terms of credit quality and asset types. Based on our experience, we know that such attention to detail can mean the difference between full payment and loss of principal if the loans backing an ABS do not perform as expected.
CMBS
PIMCO has extensive experience in the commercial real estate markets and has been intimately involved in trading the CMBS sector; we’ve continually enhanced our analytical capabilities and loan-level expertise. Specifically, PIMCO utilizes a loan-level underwriting and loss estimation model that can be applied to both CMBS bonds and many commercial real estate (CRE) collateralized debt obligation (CDO) structures. We also employ in-house experts who have experience with loan-level underwriting and collateral valuation as well as knowledge of CMBS structure, including servicing, credit enhancement and cash flow modeling.
PIMCO’s fundamental analysis begins at the individual property level, specifically with the cash flow generated by the underlying property (e.g., an office building or shopping center). We use historical property-level cash flow data under previous economic downturns to produce cash flow forecasts given PIMCO’s macroeconomic views. We segregate assets by property type and markets, applying unique forecasts to these subgroups. These forecasts are coupled with capitalization rate forecasts based on current and historical capitalization rate trends as well as those implied by other relevant markets, including REIT equities. This produces a value forecast which is applied across the pool of assets and used to forecast both loan defaults and ultimate recoveries.
PIMCO also takes a top-down approach to the sector by looking at traditional relationships between the performance of commercial real estate vs. other sectors, including investment grade corporate bonds, high yield bonds and leveraged loans, among others. Our CRE analysts work closely with analysts in these sectors to anticipate how factors within one sector (for example, the bankruptcy of a retailer) can affect the commercial real estate sector.
For CRE loans consisting of whole loans or tranches of whole loans made to a unique borrower, PIMCO has historically taken the approach of underwriting each loan individually. The underwriting is at its core a cash flow–based valuation of the collateral. We look at both the historical performance of the assets as well as the market factors that will drive future cash flow trends. We then utilize a similar capitalization rate analysis as for CMBS, with increased focus on any relevant comparable properties if possible. In each instance we rely on our specialists who have loan-level underwriting and equity valuation experience.
For CMBS, we model the probability distribution of total losses by extending the Gaussian copula correlation model used for corporate tranches. The underlying collateral is modeled as a portfolio of a small number of individual loans (reflecting the higher concentration of individual loans) and then the stochastic recovery Gaussian copula model is used with correlations implied from the corporate index tranche market. We do believe that tail risk is more probable in an individual CMBS collateral pool than in the corporate index tranche, for two reasons: First, the collateral pool in CMBS comes from commercial real estate, while the collateral backing the corporate index tranches is more broadly diversified. Second, a CMBS collateral pool consists of assets worth billions of dollars while collateral backing the corporate index tranches reflect assets worth trillions; so a catastrophic “accident” can happen to an individual CMBS pool to a greater extent. |