Will Headlines Hit Your Bottom Line? Risk and Reality in Today’s Credit Markets

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GREG HALL: Hey everybody, welcome to another episode of Accrued Interest, PIMCO’s podcast dedicated to financial advisors and their clients. Today we're gonna talk about credit markets. This is a topic that is hitting your Bloombergs, your newspapers on a daily basis, really, it seems, over the last 60 to 90 days. And of course, I'm talking about some of the headlines and tremors that we're seeing in credit markets.

What we wanted to do today is dive a little bit deeper into some of those events and then provide you all with some perspective about what this is — and maybe what it’s not as well — because there's certainly quite a lot of debate going on in markets about the significance of some of what we've seen.

And to help us in this conversation today, I'm really lucky to have Jason Duko joining us for the pod. Jason’s a Senior Portfolio Manager in our leveraged finance area. For those of you who follow credit markets actively, you'll know that leveraged finance touches a lot of the areas that have been in the news lately — whether that's private credit, CLOs, bank loans, the high-yield space. So it's nice to have somebody of Jason's wide-ranging capabilities and knowledge to join us for the conversation. Jason, thanks for being here.

JASON DUKO: Thanks, Greg. Looking forward to it.

GREG HALL: It's funny — we call you Duko around the office. It's going to be a little bit weird for me to call you Jason during the podcast, so if I lapse, I apologize.

JASON DUKO: Yeah, we can go with Duko. It's fine.

GREG HALL: There are just too many Jasons — we've got a lot of Jasons running around. So what I want to do is maybe set the stage for listeners and maybe really zoom out and think about credit markets this year from a top-down perspective.

Anybody who's listened to the podcast or read any PIMCO research over the last couple of years already knows that we have felt that expectations, spreads in corporate credit — particularly over the last few years — have been very optimistic. Spreads have been really tight. We haven't seen as much value there as we’ve seen in other parts of the market. Maybe you can bring us up to date on that viewpoint, if it still holds, and give us a sense of what's happened this year, where levels are right now, and how we're thinking about just broad credit markets right now.

JASON DUKO: Yeah, thanks Greg, it has been an interesting year because we did start the year with spreads arguably a little bit tight. We went through Liberation Day, retraced most of that, and overall it's just left us in a really solid total-return year. I think part of that was a lot of what we've been preaching — we started the year with elevated yields, and that's really helpful from a total-return perspective.

So we're seeing total returns coming into year-end in the high single digits across most credit asset classes. On the surface, a very good year. I think to your point though, what we've been feeling — and seeing in the headlines — is a lot of concerns of late-cycle behavior, recent bankruptcies, and whether the end of this more benign era is happening now. And what are we thinking about as we go into 2026?

I think that's at the front of investors’ minds, on the back of a solid year — really a solid year across. I think you called it on one of your recent podcasts: the “everything rally,” and credit did kind of benefit from that everything rally. So the way we're thinking about this at PIMCO as we look into 2026 is: we should anticipate spreads, on the surface, to look similar to where they are today.

But beneath the surface a lot of dispersion, a lot of bifurcation, elevated defaults — with particular focus on some of the lower-quality borrowers where there's less liquidity. We have concerns in that area. And I think that's going to be a challenging environment to navigate going into 2026.

GREG HALL: I know that our economic views have not called for a collapse in the economy. We have relatively benign views of overall economic performance. Maybe a little bit of a slowdown off the torrid pace of the last few years. Some unknowns about if and when tariff policies will hit, and obviously some uncertainty about exactly what the Fed will do and when.

But certainly not calling for some kind of large-scale, significant recession as our base case. We like to talk in probabilities at PIMCO because you never want to get too married to a single scenario. So it sounds to me like what I'm hearing from you is a base case that overall credit market performance looks placid on the surface — but we start to see more cracks, particularly in the lower-quality segments of the market.

JASON DUKO: Yeah, I think that's exactly right. When I describe the dispersion, you're seeing it today in a lot of the cyclicals. You look at chemicals, you look at autos, you look at the low-end consumer — there’s pressure already, and these cracks are definitely emerging. But on the other side, you have all the AI CapEx spending and the tailwinds from that still driving, to your point, decent economic growth overall.

The Fed cutting will take some pressure off some of the floating-rate borrowers as well. So there's a mix of positive and negative drivers out there. Which is why I think you'll see dispersion amongst managers, and it points to what we preach: active management is going to be really critical — trading in and out of positions, how we see credit risk is developing. Do things get oversold? We saw that post–Liberation Day, where there was definitely some overselling and we tried to capture that. I think that will be the goal going into 2026.

GREG HALL: So let’s get into the meat of what’s caused some of these headlines and some of these worries in markets of late. There have been three or four significant events — maybe more significant by virtue of the fact that they happened than by their size or systemic importance. Can you walk us through what we've seen over the last 30 to 45 days, what we’ve seen that has markets questioning what they previously thought of as a fairly — I don't want to say perfect — but I do think expectations for some credit categories were pretty much that people couldn’t be wrong. And that illusion at least has been challenged over the last month or so.

JASON DUKO: Yeah, I think that’s definitely emerged in recent months. And I think the real story is this: anytime you see rapid growth of an asset class — such as private credit, which has grown to be close to $2 trillion in size now, that's going to come with loosening underwriting standards, weaker players doing weaker deals. And then when you have these three bankruptcies take place in recent weeks, I think it opened people's eyes that maybe the underwriting you thought was being done was not being done.

GREG HALL: So we’re talking about the First Brands situation, Tricolor — all of these well-documented in the news flow, and advisors would be aware of. I think Renovo was the most recent headline to come across — and correct me on these names — and there was one more. What was the name of that issuer?

JASON DUKO: Bankai. It was a factoring fraud.

GREG HALL: Right. And I wanted to ask — there has been a debate in the marketplace as to whether these four events signify or really count as an indictment of direct lending, because some of them were held by banks, originated by banks, and some were more sponsor-backed and involved a more down the middle private-credit lender. What’s your take on that?

JASON DUKO: I would say — and Dan Ivascyn, our CIO, makes this point a lot — it’s less about public versus private and more about credit investing overall, and what type of underwriting is being done. Most importantly: are you being compensated for the credit risk you’re taking, from both fundamentally and from a liquidity standpoint?

That’s where we have the biggest concerns. It's not necessarily systemic in any meaningful way, in our opinion. I think you are going to see elevated defaults going into 2026, but this is more symptomatic of late-cycle behavior — looser underwriting — and, more importantly, not getting compensated. If you look at the direction of travel on the Fed — moving closer to a 3% base rate — and the competition between public and private markets overall, it’s leading to that spread compression.

GREG HALL: It is interesting to me — I think we sometimes fall into the temptation to talk about different markets as if they're separate and unrelated to each other. And in some cases, that behavior is fueled by managers who are looking to raise capital. They talk about the uniqueness of their strategies, and we fall into a pattern of thinking of private credit as separate from public credit or even frankly, high-yield as separate from the bank loan market or the bank loan market being separate from the IG market.

And what I hear you saying is that there’s a continuum of credit risk. It seems like it would be hard for excesses in one area of the market not to generate excesses in other areas of the market, just given that the borrowers have access to all of the markets and kind of get to select where they source funds. Am I reading that wrong?

JASON DUKO: No, no. I think that's exactly right. And this is against a backdrop, by the way, of — I mentioned this earlier — the explosion of growth in private credit. CLOs and the public bank-loan market have had back-to-back record years. There has been incredible demand coming from investors because it's been a benign credit environment against a backdrop of limited supply.

Cost of capital has remained elevated, and CFOs have been predicting a recession for a little while from the elevated base rate. They've been cautious on doing M&A and LBO activity, so there just hasn't been a lot of supply.

And so it's a simple supply-demand imbalance that has led, to your point, to sponsors taking advantage of the best path forward to finance their various transactions. They're getting looser documents, tighter spreads, and those looser underwriting standards are prevalent across all forms of credit.

GREG HALL: Yeah. And this is the dynamic that, you know, I think we've been talking about a lot on this podcast and in other client conversations, is that the success, which is most pronounced in direct lending, the success of that as an investment strategy over the last decade has led to a massive increase in appetite amongst institutional investors now, wealth investors to be involved in that because it's trailing returns look phenomenal.

And so then you have this avalanche of capital chasing, to your point, fewer and fewer deals in an uncertain economic environment and a slower deal environment. So in some respects, it's not even controversial to say that you would expect to see some deterioration in credit quality in underwriting standards because the race to put capital to work requires lenders to drop standards in order to satisfy the amount of money that's coming in from their own clients.

JASON DUKO: Yeah, I think that's exactly right. There is a pressure. I think Dan put this out there the other day when he was doing the view from the Investment Committee that a lot of clients are forced to deploy, or managers are forced to deploy, whereas at PIMCO we like to think of ourselves as an investor and look for better relative-value opportunities across that spectrum we talked about.

And so I think that's the balance you're trying to navigate as you look forward. And there definitely is that pressure, right? You don't get paid on your capital until it's deployed.

And there's a lot of competition. I think if you rewind the clock a couple of years ago, the banks were kind of sidelined by the duration problems and in retreat a little bit. And so there was this great market with elevated base rates, higher spreads, and not a lot of competition. So that was a great time, to your point.

And that's when a lot of this record fundraising took place because it was backward-looking, coming off the success of the backward-looking performance. Looking forward, I think we're saying the same thing: it's going to be lower returns going forward. And if you're expecting past performance, I think you might be a little disappointed.

GREG HALL: Right because you’ve got short rates down, which dictates the coupon you get off of a floating-rate loan, and you potentially have credit costs increasing over time. And I think, to be fair to the direct-lending folks out there, I would imagine that manager selection will play a pretty significant role in outcomes here.

If there are managers who have focused on the upper tier of quality, if they have been slower and more disciplined in capital deployment, you would imagine, all things being equal, you’d see a better outcome there with more selective, you know, GPs involved.

JASON DUKO: Yeah, that’s right. And I’m glad you put that caveat in there. I don’t think it’s all doom and gloom here. I think direct lending’s here to stay. It actually provides a very important piece of capital to the overall market. It does offer solutions for some of these lower-rated borrowers. It has more flexibility. There are definitely some positive attributes. And so I think it’s here to stay.

And you can see the dispersion that you’re describing even in the BDC prices today. Not all managers are trading at the same level of discount in terms of their stock prices today. So…

GREG HALL: Yeah. So that’s—you mentioned the BDCs before so let’s talk about that. Tell us about what you’re referring to when you reference the public BDCs and what you learn by their trading patterns.

JASON DUKO: Yeah, I mean, you mentioned in the kickoff that you can’t help but see the headlines every day. There’s always some kind of new headline related to the credit space, and a lot of times it has to do with the private-credit space because we all know that it hasn’t really been tested. It’s been a pretty benign economic environment, and people have these concerns for the reasons we’ve been talking about.

And so I think the BDC prices—especially after those bankruptcies, First Brands and Tricolor—whether they’re public or private doesn’t really matter; it just shined a spotlight that there are these late-cycle concerns. Therefore, the BDCs traded off pretty significantly. They’ve retraced a little bit in recent weeks, but they’re still trading on average, if you look at the broad index, at a 9% discount.

There’s this dispersion within that, but I think it’s just reflecting that combination of dividends likely being cut because of the base-rate and spread compression. And then on top of that, there are some fundamental concerns as we talked about.

We do think we are — if we’re not in a full credit cycle — at the beginning of a credit cycle, as evidenced by elevated PIK (paid-in-kind) interest, as evidenced by amendment activity, as evidenced by the default rate. If you look at the Lincoln data, which is typically regarded as the best source of insight into the private-credit space—

GREG HALL: These are the restructuring experts that publish periodic reports on defaults and when sponsors hand the keys back to lenders because the company is worth less than the debt load. That’s the group.

JASON DUKO: Yeah, exactly. And they’ll shine a spotlight on: What is revenue growth? What is EBITDA growth? And where are default rates? Their shadow default rate for private credit is around 6% today — pretty elevated, especially as you contrast that to high yield, which has been sub-2% default rate for the last couple of years. That’s even our forecast out to 2026.

Bank loans sit in between, with default rates hovering near the historical average of 3% to 4%. And I think that’s — at the beginning you asked about how all these markets are interconnected — I think you can see it pretty clearly in the default statistics.

High yield generally is regarded today as a higher-quality, more BB-oriented index. The bank-loan market is more of a CLO-driven index with more of a single-B focus. And as markets start to segment, the private-credit market is delivering capital to that lower-rated single-B/CCC space, with more flexibility to amend, PIK, do delay draws — there’s more of a control element there.

So the markets are segmenting, but as you take on more and more risk further out on that spectrum, you would typically see higher default rates. And that’s exactly what we’re seeing across those three different segmented markets.

GREG HALL: So I think most advisors listening will have heard all of these terms pretty frequently over the last few months, but just in case — amendments, PIK, and what was the third that you mentioned as a—

JASON DUKO: Default? An actual default.

GREG HALL: It’s been so long, Jason. So walk through again: I don’t want to suggest these are always illegitimate tools to use, but they are tools to defer payment of an obligation from a borrower to the lender, right? Whether it’s an amendment or a PIK.

So walk us through what those are and why somebody who sees rising amendments or rising deferrals or rising PIKs in their underlying investment ought to be asking some questions, shall we say?

JASON DUKO: Yeah, I think that’s fair. And again, don’t want to sound too negative here. There are good forms of PIK, if there is such a thing. Greg, I’m still skeptical — being in the credit markets 25-plus years — my history would tell me that most PIKs end in tears. You look back at the companies that have PIKed historically, it hasn’t been great from a forward-return perspective.

But today, as you look at the market in private credit, there are two forms of PIK. There’s bad PIK, which would be the companies that financed a deal in 2021 at 0%—

GREG HALL: And PIK is “paid in kind.”

JASON DUKO: Paid-in-kind interest. You’re effectively pushing out some of your interest payment to a future date. It doesn’t mean you’re fully PIKing all of your interest; it’s usually a portion.

GREG HALL: You’re adding it to the tab, you know?

JASON DUKO: Yeah, exactly, exactly. So there are two forms of PIK that the private-credit market has sort of defined today. There’s “good PIK,” which is: these are young startup companies that are still growing rapidly; they’re going to grow into their capital structure, so let’s, you know — and it’s also a way to compete with the public markets, where public markets don’t have the flexibility to do a form of PIK. So it’s a way to win deal flow in a supply-constrained market. That is “good PIK.”

And then the “bad PIK” would be the 2021 vintage, where it was financed off a 0% base rate, growth hasn’t turned out to be what they thought it would be, and they actually can’t pay their interest — and are probably on their way to a default.

So when you put the two together, it’s around 12% of total income that is coming from some form of PIK today in the BDC space. And to give context, that was in the mid-single digits just a few years ago. So it’s more than doubled.

And that’s what we’ve been seeing in the last couple of years. This phenomenon we’ve been talking about in recent months isn’t really that new. We’ve been seeing this elevated PIK activity, elevated amendment activity. And amendment activity — to define it for the listeners who aren’t aware — would be: you’re amending some of the terms within your covenants. If you’re not meeting a leverage test, an interest-coverage test, a fixed-charge-coverage test, you can go back to your lender and get an amendment and push that out a little bit, usually for an additional form of compensation.

GREG HALL: Right. And typically, there’s been some kind of credit deterioration. And again, in the non-cynical version of it, the lender and the borrower work together to bridge that gap, help the company through that — hopefully temporary — spot of trouble, and come out the other side able to repay its obligations.

If you’re looking at it more skeptically, or you’re more concerned about the economic environment, you’re probably looking at both of these phenomena and saying: “Gosh, the interest I thought I was going to get paid today has now been pushed out a few years — whatever the time period is — and so now I’m taking more risk on getting paid what I thought I was going to get paid.”

And I guess if you follow it through to the extreme, there’s some level at which — if there’s too much PIK in the portfolio, if there’s too much interest forgiveness going on — the lender becomes unable to meet the dividends that it’s paying its shareholders or that it is upstreaming to its other constituencies. Right?

JASON DUKO: That’s exactly right. And I think that’s why — going back to your question on some of the share-price pressure that we’ve been seeing — these concerns are reflected in that. And you see it also in the underlying stocks of these managers themselves, where they haven’t had a great year from a stock-performance perspective.

GREG HALL: It’s interesting. Looking at the BDC universe where we started this conversation, you mentioned a 9% discount. And we should again acknowledge that that runs the gamut, right? There are some that trade at premiums — premia, premia? I don’t want to get that Latin pluralization wrong — and there are some that trade at really steep discounts. And the average is about a 10% discount.

It’s interesting because that discount is a discount to NAV. So it’s a discount to where the manager of the BDC has told its investors it has marked the underlying loans in the portfolio. And the investors are basically saying: “We don’t want to own that exposure at that mark. We want to own it at 91 cents or 90 cents.”

Again, to your point earlier, it doesn’t mean they think it’s a huge credit problem. It could be they see forward rates coming — short rates coming down — and they anticipate a dividend cut, and they react logically.

What I think is more interesting — and I’d love for you to comment on — is: if I am an advisor or an end investor and I’ve got a choice in front of me to acquire a private BDC at NAV (which is, by definition, where private-credit portfolios in private-BDC form trade), or I can go into the market and purchase at a discount an analogous — I don’t know if they’re exactly the same — but an analogous portfolio, it seems pretty straightforward to me.

Like, if you took that trade on the PIMCO trade floor and said: “Which should I buy, the dollar for a dollar or the dollar for 90 cents?” the answer would be pretty clear.

JASON DUKO: Absolutely. And again, this is not something that you and I are only speaking about. This is out there pretty much in the public domain.

And we did see this, by the way, in the REIT space not that long ago. I think the question, when that phenomenon exists, is: does it eventually trigger outflows? Right? Because you should be doing the trade you described on the PIMCO trade floor — whenever you see that trade — selling at NAV and buying at the discount.

So if that reverses, I think that’s one of the things people are also thinking about — how do they handle those outflows? We saw what happened in the REIT space a few years ago. Gates did go up, and it did cause a little bit of pressure within that space.

So again, just one of those lingering concerns in the back of your mind, and that’s going back to the start of this conversation — against a backdrop of relatively tight relative value compared to other opportunities out in the market today. Because the Fed is cutting, there’s been spread compression, you have these looming questions that we’ve been talking about for the last few minutes.

You should be getting compensated for that liquidity premium you’re giving up — that lack of transparency. Going back to Renovo as an example, that’s one that really kind of—so I would say there are two things happening.

You had the three bankruptcies we talked about, which were more related to receivables, off–balance-sheet liabilities, and just outright fraud with weak governance and founder-owners — there were some commonalities there.

The one that I think opened people’s eyes was this week’s story on Renovo, where that loan — it’s a small middle-market private loan — was marked at par as recently as a quarter ago, and then this week it was announced that it’s actually liquidating, and the mark went from par to zero.

That is the concern you would have: when you’re marking things at NAV, what are you actually marking? So it’s a bit of a rabbit hole to go down, but that is one of the things people think about — that lack of transparency and whether the marks are accurate. And I think that, again, is one of the things weighing on investors’ minds.

GREG HALL: But the point being that the valuation here is a little bit in the eye of the beholder. And we’ve made this point on the podcast before: a manager managing a private portfolio can be doing everything right in terms of trying to arrive at the right mark for a piece of paper and still be wrong.

And what I think is interesting about the conversation we were just having is that one of the things that I find interesting about the private-BDC and private-REIT phenomenon is that you can only transact at NAV. Right?

So you have no mechanism for price discovery — or a very limited mechanism. Your mechanism for price discovery is basically whether people believe your NAV. If they do, you may have inflows; if they don’t, you’ll have outflows and potentially run into gating issues or other things.

But that’s really the only way you can determine whether or not the market “believes” or values your holdings at the same level that you do as a manager.

Whereas in the public markets, with the public BDCs, in real time you get that feedback, and it gives you a sense. And that’s why I think we’re watching flows in the direct-lending space so carefully right now — because the public markets, on average — not for every issuer — are telling you they don’t value the holdings at the same level as where they’re marked, and they would prefer a higher rate of return on those.

And we’ll see if that then translates through to the buyers of the more-private vehicles.

JASON DUKO: I think what would be a major driver of this — you need some sort of economic shock. Because I think if you don’t have that, if the economy kind of chugs along, you get a 2-plus-percent growth, yes, you’ll have some idiosyncratic events like we’ve talked about, but I don’t think it becomes a full-scale recession where you’re seeing deep discounts, gates go up, etc.

I think you need some sort of catalyst to make that next step happen. And right now that’s not in our forecast, to be clear.

GREG HALL: Yeah, I hear you on that. I sometimes think one of the new variables in this space is the increasing prevalence of the wealth market. And, you know, I serve the wealth market — I think the advisors I speak to are phenomenally sophisticated, patient, good investors on behalf of their clients.

And so I take umbrage when people refer to it as “fast money,” but I do think that advisors want to get the most for their clients at any given point in time and have the freedom to look elsewhere for value when they don’t feel like it's apparent in their current holdings.

And so there is, I think, a variable here, which is: you’ve got more wealth investors involved in this space than you ever have before. And if forward return expectations begin to come down meaningfully — if credit fears evolve from just these idiosyncratic headlines to something that feels a little more like late-cycle credit-default behavior, that you’ve already mentioned we’re seeing signs of — then you could actually see some meaningful retrenchment in the space.

JASON DUKO: I think that’s right. And as you were talking through that, I don’t want to underestimate the risk you’re describing, because it is a real risk out there. And I would say, if I back up and summarize the way I’m thinking about that space in general — and it’s not just, to your point, public/private or private-only. It’s public and private — the cockroach story… it’s funny, we’re 20–30 minutes in, we haven’t mentioned a cockroach once, and—

GREG HALL: Yeah.

JASON DUKO: But that general cockroach late-cycle behavior — how many are there, etc. I think Howard Marks had a funny saying on that the other day: the canary in the… or the cockroach in the coal mine. I thought that was pretty clever.

GREG HALL: Way to mix a metaphor, Howard. That’s good.

JASON DUKO: So you’ve got that story happening — that’s number one. Number two, you have the PIK, amendment, default activity that we talked about. And the one you should be thinking about as well — and this is a big story in the broader markets as well is technology.

We haven’t mentioned that yet, but that’s the third caveat you should be thinking about in the credit markets. This is impacting all the way from investment grade — all the data-center activity we’re seeing — all the way down to private credit, where they have a lot of concentration in enterprise software. If you look across — and by the way, in the public bank-loan markets as well as it’s about 15–20% of the sector concentration.

So all this technology concentration is something I think is going to be a big risk factor on a go-forward basis. If you think about 20–30% (raw numbers) of the BDCs being exposed to technology, I think that’s a big looming risk, because we just don’t know how it’s going to play out yet as AI gets deployed. Does it disrupt? Does it dislocate?

And I would expect recoveries to be pretty nasty — if you get the bankruptcy, because obsolescence risk becomes the biggest risk there. These are not worth anything if the technology gets disintermediated.

GREG HALL: Yeah. And I think maybe we take a little too much comfort in prior performance — and I don’t just mean track records of investment managers we may invest in, but also past patterns of behavior.

So software — SaaS software, right? Software-as-a-service five years ago, 10 years ago — looked like an incredibly attractive, reliable, predictable revenue stream and an asset-light, CapEx-light company. And AI throws that for a loop, right? And we don’t really know where that ultimately bottoms out, but we have every reason to expect it will be different than people assumed a decade ago.

And then the other thing you mentioned is recovery rates. There’s this rule of thumb in credit investing that recovery rates are usually around 60–70%. And we just don’t know, right? Because, one, you mentioned the sector exposure has changed — but also the documentation has changed over the years. And so I don’t know, in a cov-lite document, what a lender can seek to recover in a situation like that.

JASON DUKO: Well, yeah. Actually, right before I came in today, I was reading that JP Morgan put out a study through the third quarter on what recoveries look like on an LTM basis and they’re pretty bad, Greg. The bank-loan recovery is less than 40 cents on an LTM basis today. And historically that would be 60–80 cents.

So well below — and I think it’s the sixth consecutive year that it has come in below the historical average. So, a clear trend of recoveries going lower. That’s a function of more loan-only issuers with less subordination in the capital structure, and also this concept of weaker governance, to your point.

So these LMEs — Liability Management Exercises where you have creditor-on-creditor violence, with different sets of lenders getting different recoveries… that combination has been pretty brutal when you find yourself in those stressed situations in the bank-loan market. You’re also seeing low recoveries in high yield. So it’s prevalent across bank loans, high yield, and private credit.

GREG HALL: So it’s interesting. From our conversation, it sounds like there are headwinds in corporate credit generally — and particularly at the lower-quality end of that — whether it’s bank loans, private credit, maybe to a lesser extent high-yield (because as you mentioned, that cohort has gravitated to slightly higher quality over time).

But it sounds like we’ve got declining coupons, for the most part, in the floating-rate sector. It sounds like we have some unanswered questions in terms of whether the “cockroaches” are really emblematic of broader problems — but at the end of a long cycle, there’s no reason to think that’s a crazy hypothesis.

It sounds like there’s an open debate as to whether or not the underwriting standards and the concentrations we’ve talked about really belong to just one market — say, the bank-loan market versus the private-credit market — or if they’re more widespread.

And we have a little bit of added economic uncertainty, though we are not calling as a base case for a major recession.

It doesn’t occur to me that we’ll be changing our views to be more bullish on any of these sectors anytime soon. And I say that full well knowing that I’m talking to the bank-loan guy when I say that.

JASON DUKO: Yeah, I think that's exactly right. And so in general, we're preaching: stay up in quality, stay liquid, be careful with the cyclicals right now. As an example, not everything is terrible. A lot of the sectors that went through some restructuring pressure a couple of years ago — telecom, healthcare — they've come out in a decent position on the other side of that.

GREG HALL: You mentioned the REITs and I think that we're constructive by and large on real estate debt. So, yeah.

JASON DUKO: REITs as well. And on the high-end consumer, the consumer that owns a house — there are definitely places to find value within the market. I think it's again going back to active management: rotating in and out of sectors as we see value, and most importantly maintaining liquidity. And if you're going to give up that liquidity, just make sure you're getting compensated appropriately for that.

GREG HALL: Hey Jason, you mentioned factoring as part of the Bankai situation, I think it was. And factoring is something that falls in the asset-based finance category. One of the things we like to mention to investors is that asset-based finance is not some new phenomenon that the private-credit guys thought up in the last two or three years. It's an old and established deep market that we at PIMCO have been involved in for the duration of our history, and particularly in some of our large multi-sector products — really deep into a lot of those spaces.

And I guess the thrust of my question is: I've always thought the entry barriers to being really good in asset-based finance are pretty high. Just being able to conduct diligence on that variety of assets, to have maybe had some of the scars related to being defrauded or where the assets aren't where they're supposed to be.

I know this isn't your daily area of focus, but what's your impression of some of the differentiation between the corporate-lending landscape right now versus the asset-based lending landscape?

JASON DUKO: It's an interesting question, right? Because as a firm, we're definitely favoring asset-based financing as a better relative-value trade today. But with the caveat that it's becoming a little bit of a crowded trade. And I think as the private-credit corporate markets have matured, you're seeing a lot of these managers pivot over to the asset-based finance market. And therefore they're not as entrenched in the space. They don't have the resources or history, to your point, of doing the deep dive.

If you look at First Brands and Bankai— just basic diligence wasn't done. Bankai was outright fraud they were making up transactions and mailing them in when there was no telecom company. They didn't have any customers on the other side.

At PIMCO we pride ourselves on doing our own diligence, having great resources to verify the collateral, and being careful where we are doing the type of asset-based financing as well.

Again, reinforcing: where the consumer is high-end, where the collateral pools — bespoke or public — typically where they own a home. The contrast between homeowner net worth and non-homeowner net worth is as big as it's ever been. And we will focus on those areas of the market. I don’t know if the broader market is being as discerning as they navigate that space.

GREG HALL: Yeah. I think the point about asset-based lending that I find most compelling is: it does carry some additional risks in the sense that a more granular asset base, you know, some areas of asset-based lending are not like others. It's a big category.

But if you bring tested institutional processes, we think you can take advantage of what is today still a far less crowded landscape than what you see in corporate direct lending. And I think it's important to mention to advisors that just because it's less crowded today doesn’t mean it will be less crowded tomorrow. We all have to keep an eye on that and not fall into the trap that maybe folks have in the direct-lending space of late, which is to assume that because the last five years were great, the next five years will be great.

Everything's cyclical. Capital chases returns, returns go down — it’s the oldest story in markets. And so we just have to be vigilant about that. And to your point earlier in the conversation: stay active. Some of these private-credit strategies to us look as passive as an index. I'm exaggerating, but doing every loan that crosses your desk — that's not selectivity, that's not care, that’s capital deployment. You can do that, and if you get the beta right it can be successful, but it's not active management.

JASON DUKO: Exactly right. And going back to your point on ABF — it’s not just which tranche you are investing in. Are you up in the cap structure? Down in the mezz, etc.? Different parts of asset-based finance differ. It’s hard to speak at a high level because it is so nuanced across these sub-sectors.

GREG HALL: All right, Duko, thank you so much for spending all this time with us. There’s a lot going on out there, a lot to parse through, and you’ve given us a really measured and balanced sense of the pushes and pulls on the credit markets right now. I think advisors — it’s a great framework you’ve given them. They can take this to their clients. They can talk about “on the one hand and on the other,” which sometimes is better than banging the table one way or the other because these are complicated, nuanced things and they deserve careful thought.

So thanks for bringing that to us. We really appreciate it. Love to have you back sometime — maybe next year some of these trends work themselves out and we’ll be able to test whether our hypotheses and our frameworks held true.

JASON DUKO: Great. Well, thank you for having me, Greg.

GREG HALL: Alrighty. Hey, thanks everybody for listening. We’ll be back next month with another great podcast. We really appreciate you spending the time with us on Accrued Interest. As you know, Accrued Interest is part of the Advisor Forum platform here at PIMCO.

Advisor Forum is your destination at PIMCO for the research and insights you need for quality client conversations and to make your days as efficient and pragmatic as possible. We appreciate you spending the time with us, and we’ll talk to you next time.