Bank Retrenchment Creates Attractive Opportunities for Credit Investors

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Text on screen: What is the origin of the shift in the private credit environment in the past two years, and what are the key opportunities and pitfalls as you assess the private credit landscape?

Credit is going through a real moment right now where returns are very interesting across, really across the liquidity spectrum, private and public.

Text on screen: Christian Stracke, President and Head of Global Credit Research

But a lot of what's, driving this change, especially in the private markets, is what's happening with banks.

And so the way that we think about it, and I think in some of the slides we, we talk about it, the, there's a fundamental retrenchment of banks going on right now that is different from how it was over the last, many years.

Full page graphic title: Bank retrenchment has accelerated since the regional bank crisis in 2023. There are two charts. The first chart is titled Cumulative loan growth for US banks. The years covered are 2022, in the blue line, 2023 in green, and 2024 in purple. The highest loan growth was in 2022 at close to 11%. Loan growth dropped significantly to 2% in 2023, and close to 3% in 2024. The text on the left of the chart reads SVB Failure in 2023 Week 11, referring to California-based Silicon Valley Bank’s collapse. The second chart on the right is titled Q4 2024 loan growth of regional banks (% YoY ). It shows the majority of regional banks reducing lending, as shown in the green bars on the right, with declining loan growth for PNC, Regions, Truist Financial,  Synovus, and Citizens Bank. The bars on the left shows three banks with increasing loan growth. These banks are First Horizon, US Bancorp, and M&T Bank. The footnotes at the bottom of the charts read: As of 31 December 2024. Source: PIMCO, Federal Reserve Bank of St. Louis. For illustrative purposes only. There is no guarantee that the trends mentioned above will continue. Statements concerning financial market trends are based on current market conditions which will fluctuate. Refer to appendix for additional chart outlook and risk information.

There's a change right now, happening that's since what happened in, in 2023, the collapse of the regional banks.

So what we've seen is that it's not just regulation. The story for a long time was regulation and tightening of regulation, and that is still, at play.

But what happened in 2023 was not regulation, it wasn't a lack of capital. It wasn't credit problems and balance sheets, it was interest rate volatility.

And that interest rate volatility drove an extension of the duration of assets on bank balance sheets, and it drove a decline in the duration of liabilities on bank balance sheets.

And so you have this asset liability mismatch that is chronic, in banks.

And so banks have really taken a look at that and said, how can I work with this? How can I work in a higher interest rate world, a more volatile interest rate world that optimizes the balance sheet?

And so you hear this buzz word of balance sheet velocity, and what that means is a move from originate to hold on balance sheet to originate, to distribute, hold some on balance sheet, but look for partners outside, of the banks.

And that is the opportunity for asset managers and ultimately the opportunity for investors all over the world.

Full page graphic title: Bank retrenchment has accelerated since the regional bank crisis in 2023. There are two charts. The first chart is titled Cumulative loan growth for US banks. The years covered are 2022, in the blue line, 2023 in green, and 2024 in purple. The highest loan growth was in 2022 at close to 11%. Loan growth dropped significantly to 2% in 2023, and close to 3% in 2024. The text on the left of the chart reads SVB Failure in 2023 Week 11, referring to California-based Silicon Valley Bank’s collapse. The second chart on the right is titled Q4 2024 loan growth of regional banks (% YoY ). It shows the majority of regional banks reducing lending, as shown in the green bars on the right, with declining loan growth for PNC, Regions, Truist Financial,  Synovus, and Citizens Bank. The bars on the left shows three banks with increasing loan growth. These banks are First Horizon, US Bancorp, and M&T Bank. The footnotes at the bottom of the charts read: As of 31 December 2024. Source: PIMCO, Federal Reserve Bank of St. Louis. For illustrative purposes only. There is no guarantee that the trends mentioned above will continue. Statements concerning financial market trends are based on current market conditions which will fluctuate. Refer to appendix for additional chart outlook and risk information.

And if we go back on that slide that we, that we just had, what we see is that in 2022, before the collapse of the regional banks, you had very high growth in bank lending and what's happened in 2023 and 24 is that bank lending has collapsed. That bank lending as a share of GDP is declining and you see outright declines in nominal terms in regional banks.

But interestingly, what's happening while this is happening is that banks, while they're not really willing to hold a lot of their residential mortgages on balance sheet, their consumer loans on balance sheet, their equipment, loans on balance sheet aviation, infrastructure, debt on balance sheet, they are willing to lend against those loans.

And so the one area that's been growing at banks is loan on loans, nav lines, subscription facilities, things like that. That is a huge growth area for banks, and it's a huge opportunity for asset managers and ultimately investors as this move of credit out of the banking system into a much more balanced, much more hybrid world of banks, asset managers and other non-bank lenders.

Text on screen: Are you looking at investing in data centers in the US and around the world today, and if so, what kind of credit underlines that data center?

So for us, very much so in the US and in Europe, in the US mostly debt in the US mostly private IG transactions to help, some of these IG companies keep this debt off of the balance sheet. Very interesting, very interesting pickup to the liquid credit. but you have a look through guarantees from these double A, single A, triple A, borrowers.

In Europe we are actively investing in, construction and development of data centers in tier two markets, which is really one of the most interesting, development markets in the world right now. Because it's under invested, it's difficult to invest in, the hyperscalers, the big, tech companies don't want to do it themselves because it is very complicated to get the land, to permit the land, to get the power, to pull it all together. And so that's where there are some returns to the complexity of the opportunity. So there we're, we're very excited about that.

Text on screen: Give us your view of the dramatic changes you have seen in the credit markets and how it might play out on your international investing in the next year or two?

Text on screen: Christian Stracke, President and Head of Global Credit Research

I'd say two major and really radical transformations that we've seen in recent years. One is, and Mike you mentioned it, I mean, you know, there's the liquidity in credit markets. I mean, you mentioned that once upon a time, it took two months to trade, a public corporate bond. Today with the rise of the all to all platforms in liquid credit, you can sell those bonds in two seconds.

The liquidity in IG credit is unlike anything we've seen in our careers and facilitated by technology, facilitated moving outside of the banking system into these, technology platforms.

So that's a radical change, which has really, facilitated the liquidity in this market.

There are really interesting illiquidity premiums in private IG as well, but I think it's important to recognize just how strong liquidity is in credit markets.

Now the other thing is that rise of asset-based finance, but particularly in the global, spectrum.

And so what we've seen in the last couple of years is a move from asset-based finance, which was really a US phenomenon, now very much a European phenomenon as European banks, as European governments realize that they need more diversified credit sources looking at areas outside of banks, asset managers, non-bank lenders, et cetera, to provide that asset-based finance.

So that is a, a fundamental transformation that's happening right now.

We've deployed at PIMCO several billion in Europe in asset-based finance over the last couple of years. And we think that there's a lot more growth to come in the, in the years ahead.

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References to specific securities or asset classes are not intended and should not be interpreted as recommendations to purchase, sell or hold such securities. Past performance is not a guarantee or a reliable indicator of future results.

All investments contain risk and may lose value. Private credit involves an investment in non-publicly traded securities which may be subject to illiquidity risk. Portfolios that invest in alternatives and private credit may be leveraged and may engage in speculative investment practices that increase the risk of investment loss. Corporate debt securities are subject to the risk of the issuer’s inability to meet principal and interest payments on the obligation and may also be subject to price volatility due to factors such as interest rate sensitivity, market perception of the creditworthiness of the issuer and general market liquidity. Investing in distressed loans and bankrupt companies is speculative and the repayment of default obligations contains significant uncertainties. Bank loans are often less liquid than other types of debt instruments and general market and financial conditions may affect the prepayment of bank loans, as such the prepayments cannot be predicted with accuracy. There is no assurance that the liquidation of any collateral from a secured bank loan would satisfy the borrower’s obligation, or that such collateral could be liquidated. Investments in residential/commercial mortgage loans and commercial real estate debt are subject to risks that include prepayment, delinquency, foreclosure, risks of loss, servicing risks and adverse regulatory developments, which risks may be heightened in the case of non-performing loans. Mortgage and asset-backed securities are highly complex instruments that may be sensitive to changes in interest rates and subject to early repayment risk. Real asset investments including those in data centers are subject to a variety of inherent risks that may have an adverse impact on the values of, and returns (if any) from, such investments, including changes in the general economic climate and local conditions. Structured products such as collateralized debt obligations are also highly complex instruments, typically involving a high degree of risk; use of these instruments may involve derivative instruments that could lose more than the principal amount invested. Sovereign securities are generally backed by the issuing government. Investing in foreign denominated and/or domiciled securities may involve heightened risk due to currency fluctuations, and economic and political risks, which may be enhanced in emerging markets. High-yield, lower-rated, securities involve greater risk than higher-rated securities; portfolios that invest in them may be subject to greater levels of credit and liquidity risk than portfolios that do not.

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