Asset-Based Finance Explained

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Text on screen: Elliot Mcilrath, Product Strategist, Alternative

Elliot Mcilrath: Hi, I'm Elliot McIlrath, product strategist for alternative credit in Pimco's UK team.

You may have heard about asset-based finance and wondered what it is all about. Let me help demystify the exciting evolution in private credit.

Text on screen: What is asset-based finance?

Asset based finance, or ABF for short,

Text on screen: ABF is private lending outside traditional corporate and CRE lending

Images on screen: Plane taking off, Car dealership

refers to any kind of private lending that occurs outside of traditional corporate lending or commercial real estate markets. It's also referred to as asset backed finance or specialty finance.

Images on screen: Car dealership, residential neighborhood, airplane in flight, college students, credit card transaction

ABF provides critical funding across the global real economy and 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 and holiday, attend university, or purchase goods on a credit card.

Text on screen: ABF loans are often backed by hard assets

Images on screen: Machinery at a construction job site

From an investing perspective. ABF 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, a plane, or financial guarantees like business receivables and intellectual property rights such as royalties, just to name a few.

Text on screen: How large is the ABF universe?

At Pimco,

Text on screen: US$20 trillion ABF market, by PIMCO’s estimates

Source PIMCO as of September 2024. Based on latest data available.

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we estimate the ABF market to be over $20 trillion. Much of this fixed income like universe is held by banks or pulled into securitizations.

But a major shift towards private markets is underway,

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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 ABS 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 finance to be the next frontier of private credit.

We've mentioned some examples already, but at a high level, the ABF universe can be broken down into three main categories consumer, non consumer and mortgages.

Text on screen: TITLE – Consumer, BULLETS – Auto loans, Student loans, Personal loans

The consumer category includes consumer orientated credit such as auto loans, credit card receivables, student loans, or other types of personal loans.

Text on screen: TITLE – Non-consumer, BULLETS – Aviation finance, Royalty streams, Equipment leasing

Non consumer areas are more business related, including aircraft leasing, royalty streams such as music or heavy equipment finance such as manufacturing equipment.

Text on screen: TITLE – Mortgages, BULLETS – U.S. residential mortgages, European residential mortgages, Home improvement loans

Finally, the mortgage category includes residential mortgages in the UK, Europe and the US, as well as home improvement loans.

As you can see, ABF is a highly diverse credit market. However, most investors remain underexposed to this asset class, particularly in private markets.

Text on screen: Why do we believe ABF is attractive for investors?

We think ABF is attractive for investors today for three key reasons.

Text on screen: TITLE –The main advantage of Asset-Based Finance, BULLETS – A target-rich and growing opportunity set

First and foremost, ABF has a target rich, rapidly expanding opportunity set that we believe offers a compelling risk return profile, relatively high barriers to entry mean valuations today are attractive relative to historical levels. At the same time, ABF defensive qualities of a potential downside mitigation as ABF loans are usually secured by physical assets, providing an often senior secured investment profile.

Text on screen: TITLE –The main advantage of Asset-Based Finance, BULLETS – A target-rich and growing opportunity set with a compelling risk-return profile, Portfolio diversification

The second key advantage is a portfolio diversification. Private credit has matured in recent years. And in particular corporate lending has seen elevated competition with most private credit investors heavily allocated in this area.

Adding private ABF to a portfolio could potentially be highly complementary to investors credit allocation, given the idiosyncratic, low correlated nature to other parts of private credit. ABF loans also tend to be paid back more quickly due to amortizing payment schedules, meaning there is less guesswork on whether you will be repaid. This adds yet another dimension of diversification relative to corporate lending, where coupon payments interest only and a loan is only repaid at the end of time, meaning investors often have to guess how well a company will be doing several years in the future.

Text on screen: TITLE –The main advantage of Asset-Based Finance, BULLETS – A target-rich and growing opportunity set with a compelling risk-return profile, Portfolio diversification, ABF has a compelling entry point

Lastly, ABF has a very compelling entry point today. Stress in the US banking sector and tighter regulations have created large liquidity gaps left by banks pulling back. Private lenders like Pimco are stepping in to fill that gap.

Partnering with banks looking to optimize their balance sheets by

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selling assets or seeking other partnerships. Scale, close relationships and a deep understanding of these markets will offer strategic opportunities for investors with flexible capital.

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So the next time you take a flight or buy something with your credit card, remember the critical role asset based finance plays in the global economy and the potential benefits it offers to investors.

Text on screen: For more insights and information, visit pimco.com

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Disclosure

This material (the “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.

The investment strategies discussed herein are speculative and involve a high degree of risk, including a loss of some or all capital. Investments in any asset classes described herein may be volatile, and investors should have the financial ability and be willing to accept such risks.

All investments contain risk and may lose value. 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 including default, liquidity, management, volatility interest rate and credit 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-publically 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. Mortgage- and asset-backed securities may be sensitive to changes in interest rates, subject to early repayment risk, and while generally supported by a government, government-agency or private guarantor, there is no assurance that the guarantor will meet its obligations.

Statements concerning financial market trends or portfolio strategies are based on current market conditions, which will fluctuate. There is no guarantee that these investment strategies will work under all market conditions or are appropriate for all investors and each investor should evaluate their ability to invest for the long term, especially during periods of downturn in the market. Outlook and strategies are subject to change without notice.

Certain information contained herein concerning economic trends and/or data is based on or derived from information provided by independent third-party sources.  PIMCO believes that the sources from which such information has been obtained are reliable; however, it cannot guarantee the accuracy of such information and has not independently verified the accuracy or completeness of such information or the assumptions on which such information is based.

This material contains the opinions of the manager and such opinions are subject to change without notice. This material has been distributed for informational purposes only and should not be considered as investment advice or a recommendation of any particular security, strategy or investment product.

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