Asset-Based Lending 101
Kyle McCarthy: Hi, I'm Kyle McCarthy, a private credit specialist here at PIMCO.
You may have heard about asset-based lending and wondered what it’s all about. Let us help demystify this exciting evolution in private credit.
Asset-based lending, or ABL for short, refers to any kind of private lending that occurs outside the traditional corporate and commercial real estate lending markets. It is also referred to as asset-backed or asset-based finance, or specialty finance.
ABL provides critical funding across the global real economy in categories you interact with daily. In fact, it’s what enables us to finance a car purchase, or obtain a home mortgage, take a flight on vacation, attend university, or purchase goods on a credit card.
From an investing perspective, ABL loans are often secured by hard assets as collateral, which typically support the cash flows of the investment itself. This could be a house, a car, an airplane, or financial guarantees like business receivables and intellectual property rights, such as royalties, just to name a few.
At PIMCO, we estimate the ABL market to be over 20 trillion dollars. Much of this fixed-income-like universe is held by banks or pooled into securitizations. But a major shift towards private markets is underway, which we believe is creating a multi-trillion opportunity set for alternative lenders in the coming years.
PIMCO has been actively investing in various forms of ABL for decades, with our fixed income DNA crucial in making us one of the largest and most experienced investors in this space. Diverse and growing, we consider asset-based lending the next frontier of private credit.
We’ve mentioned some examples already, but at a high-level, the ABL universe can be broken down into three main categories: consumer, non-consumer, and mortgage.
The consumer category includes consumer-oriented credit and debt such as student and auto loans, credit card receivables, and other personal loans.
Non-consumer areas are more business-related, including aircraft leasing, heavy equipment finance, and royalty streams.
Finally, the mortgage category includes single-family residential mortgages in the U.S. and Europe, as well as home improvement loans.
As you can see, ABL is a highly diversified credit market. However, most investors remain underexposed to this asset class, particularly in private markets.
We think ABL is attractive for investors today for 3 key reasons.
First and foremost, ABL has a target-rich, rapidly expanding opportunity set that offers a compelling risk-return profile. Relatively high barriers-to-entry mean valuations today are attractive relative to historical levels. At the same time, ABL’s defensive qualities offer potential downside mitigation, as ABL loans are usually secured by hard assets, providing an often senior secured investment profile.
The second key benefit is portfolio diversification. Private credit has matured in recent years. In particular, corporate direct lending has seen elevated competition, with most private credit investors heavily allocated in this area. Adding private ABL to a portfolio could be highly complementary to investors’ credit allocation, given the idiosyncratic, low correlated nature of the underlying assets. ABL cash flows also tend to be front-loaded and amortizing, meaning they de-risk over time. This adds another dimension of diversification relative to corporate direct lending, where coupon payments are interest-only.
Lastly, ABL has a very compelling entry point today. Stress in the U.S. banking sector and tighter regulations have created large liquidity gaps left by banks pulling back. Private lenders like PIMCO are stepping in to fill the gap, partnering with banks looking to optimise their balance sheets by selling assets or seeking origination partnerships.
Scale, close relationships, and a deep understanding of these markets will offer strategic advantages for investors with flexible capital.
So, the next time you take a flight or buy something with your credit card, remember the critical role asset-based lending plays in the global economy – and the potential benefits it offers investors.
Disclosure
This material is being provided for informational purposes only and does not constitute an offer to sell or a solicitation of an offer to buy interests in a fund or any other PIMCO trading strategy or investment product. Past performance is not a guarantee or a reliable indicator of future results.
The material contains statements of opinion and belief. Any views expressed herein are those of PIMCO as of the date indicated, are based on information available to PIMCO as of such date, and may not have been updated to reflect real time market developments. Statements of opinion are subject to change, without notice, based on market and other conditions. No representation is made or assurance given that such views are correct. PIMCO has no duty or obligation to update the information contained herein.
All investments contain risk and may lose value. Investments in asset-based lending and asset-backed instruments are subject to a variety of risks that may adversely affect the performance and value of the investment. These risks include, but are not limited to, credit risk, liquidity risk, interest rate risk, operational risk, structural risk, sponsor risk, monoline wrapper risk, and other legal risks. Asset-backed securities across various asset classes may not achieve business objectives or generate returns, and their performance can be significantly impacted by fluctuations in interest rates. 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. 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. Private credit involves an investment in non-publicly traded securities which may be subject to illiquidity risk. Portfolios that invest in private credit may be leveraged and may engage in speculative investment practices that increase the risk of investment loss. Additionally, investments in private credit may be subject to real estate-related risks, which include new regulatory or legislative developments, the attractiveness and location of properties, the financial condition of tenants, potential liability under environmental and other laws, as well as natural disasters and other factors beyond a manager’s control. Investing in banks and related entities is a highly complex field subject to extensive regulation, and investments in such entities may give rise to control person liability and other risks. Investing in distressed loans and bankrupt companies is speculative, and the repayment of default obligations contains significant uncertainties.
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References to specific securities and their issuers are not intended and should not be interpreted as recommendations to purchase, sell or hold such securities. PIMCO products and strategies may or may not include the securities referenced and, if such securities are included, no representation is being made that such securities will continue to be included.
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