WEBVTT NOTE Created by CaptionSync from Automatic Sync Technologies www.automaticsync.com 00:00:01.206 --> 00:00:04.846 align:middle >> You're listening to All the Credit, a monthly podcast series brought to you 00:00:04.846 --> 00:00:09.416 align:middle by PGIM Fixed Income, an active global fixed income investment manager. 00:00:10.386 --> 00:00:11.426 align:middle >> Welcome to All the Credit. 00:00:11.656 --> 00:00:14.136 align:middle I'm Brian Barnhurst, global head of credit research. 00:00:14.646 --> 00:00:18.736 align:middle Today's episode is the first in a series that will explore credit markets in transition. 00:00:19.556 --> 00:00:22.736 align:middle We're going to focus on the fast-growing headline grabbing world 00:00:22.736 --> 00:00:24.756 align:middle of ABFs, Asset-Based Finance. 00:00:25.116 --> 00:00:27.366 align:middle I'm fortunate to be joined by long-time colleague, 00:00:27.546 --> 00:00:29.776 align:middle Co-Head of Structured Products, Edwin Wilches. 00:00:30.146 --> 00:00:32.256 align:middle Edwin, great to have you on the podcast. 00:00:32.256 --> 00:00:33.586 align:middle >> Thanks so much, Brian. 00:00:33.586 --> 00:00:35.226 align:middle I'm really looking forward to the discussion today. 00:00:35.426 --> 00:00:38.266 align:middle >> So to start, ABF is a bit of a catch-all. 00:00:38.516 --> 00:00:39.946 align:middle How do you define it? 00:00:40.606 --> 00:00:46.526 align:middle >> Sure, so ABF, or asset-based finance, can feel a bit like an all-encompassing label 00:00:46.526 --> 00:00:50.426 align:middle and that's likely because the investment market references trillions of dollars. 00:00:50.836 --> 00:00:55.746 align:middle At its core, ABF refers to lending that is secured by a specific set of assets 00:00:55.796 --> 00:00:57.546 align:middle that generate contractual cash flows. 00:00:57.716 --> 00:01:01.686 align:middle This can include consumer assets, such as auto loans, credit cards, student loan, 00:01:01.686 --> 00:01:04.916 align:middle and can include hard assets coming from commercial sectors, 00:01:04.916 --> 00:01:07.246 align:middle like transportation or digital infrastructure. 00:01:07.416 --> 00:01:10.856 align:middle It includes financial assets, such as inventories or receivables, 00:01:10.856 --> 00:01:12.506 align:middle or even sectors like fund finance. 00:01:12.776 --> 00:01:14.836 align:middle It even includes things like mortgages. 00:01:14.836 --> 00:01:16.736 align:middle Now, you might say that sounds an awful lot 00:01:16.736 --> 00:01:19.716 align:middle like what we call securitized products, and that's because it is. 00:01:19.986 --> 00:01:23.186 align:middle Generally the ABF label is used for private market investments 00:01:23.186 --> 00:01:26.066 align:middle that our teams are directly originating from issuers. 00:01:26.436 --> 00:01:30.086 align:middle PGIM has been investing in securitized products since the 1990s. 00:01:30.346 --> 00:01:33.126 align:middle Being the dad that I am, I like to joke that what is old is new again. 00:01:33.126 --> 00:01:35.226 align:middle Kind of like ripped jeans and bell bottoms. 00:01:35.686 --> 00:01:38.926 align:middle In the late '90s we were the first investors in the securitization 00:01:38.926 --> 00:01:43.206 align:middle of intellectual property rights of David Bowie, and what became the first music royalties deal, 00:01:43.246 --> 00:01:45.786 align:middle which in the last few years has once again gained popularity 00:01:45.786 --> 00:01:48.006 align:middle as the new, hot sub-sector of ABF. 00:01:48.136 --> 00:01:52.106 align:middle So really putting all that together, at PGIM we think it makes a lot of sense 00:01:52.106 --> 00:01:56.636 align:middle to have one securitized credit team focused on what we simply think of as asset-based finance, 00:01:56.776 --> 00:01:58.426 align:middle whether that's public or private. 00:01:58.426 --> 00:02:03.336 align:middle >> If I think about the evolution of this market, some things about the development 00:02:03.336 --> 00:02:09.816 align:middle of ABF were very obvious, changes in regulation post-GFC, changes in the behavior of banks, 00:02:09.816 --> 00:02:12.966 align:middle naturally creating opportunities for others in the marketplace. 00:02:13.066 --> 00:02:18.396 align:middle On the other hand, it feels to some degree as if the excitement and the attention 00:02:18.396 --> 00:02:22.866 align:middle around ABF came a little bit out of nowhere in the last couple of years. 00:02:22.916 --> 00:02:26.996 align:middle So why is ABF garnering so much attention now? 00:02:26.996 --> 00:02:29.896 align:middle What are the attributes that have really captured the attention 00:02:29.896 --> 00:02:31.976 align:middle of both market [inaudible] and investors? 00:02:32.526 --> 00:02:36.366 align:middle >> Yeah, it is really a confluence of multiple things happening at the same time. 00:02:36.366 --> 00:02:39.676 align:middle So, on one hand, as you mentioned, there is a secular change 00:02:39.676 --> 00:02:43.396 align:middle in how bank balance sheets are calibrated, due to in part, regulatory pressures, 00:02:43.396 --> 00:02:46.286 align:middle as well as kind of how they optimize their ROEs today. 00:02:46.526 --> 00:02:52.446 align:middle Post-GFC Dodd-Frank did shift the focus from banks away from taking pure credit risk, 00:02:52.726 --> 00:02:56.936 align:middle to help decrease the fragility of the banking system and improve financial stability. 00:02:57.016 --> 00:03:00.616 align:middle What that really meant was prop desks were dissolved, risky credit, 00:03:00.616 --> 00:03:05.856 align:middle things like high yield corporate loans, became what we call today the bank loan market, ClOs, 00:03:05.856 --> 00:03:10.456 align:middle retail funds, institutional investors, obviously quite active in that trillion 00:03:10.456 --> 00:03:14.056 align:middle and a half million dollar market, and other things like lower credit consumers, 00:03:14.056 --> 00:03:17.646 align:middle or aircraft leasing ultimately landed on the balance sheets 00:03:17.646 --> 00:03:22.136 align:middle of non-depository financial institutions, so think whether it's securitization or even things 00:03:22.136 --> 00:03:24.246 align:middle like insurance companies and definitely private credit. 00:03:24.246 --> 00:03:30.136 align:middle So, ultimately these riskier investments, if you will, landed in a part of the financial system 00:03:30.136 --> 00:03:32.686 align:middle where they weren't subject to overnight deposits, right? 00:03:32.686 --> 00:03:33.766 align:middle That's all been positive. 00:03:33.766 --> 00:03:39.076 align:middle I think in the last few years what we've also seen is the regulatory focus has shifted a bit 00:03:39.076 --> 00:03:42.366 align:middle away from just the largest banks to also the large regional banks. 00:03:42.366 --> 00:03:47.106 align:middle And actually this happened after Silicon Valley Bank failure and First Republic and others, 00:03:47.106 --> 00:03:51.266 align:middle that really highlighted other cracks in the system that go beyond just credit risk. 00:03:51.426 --> 00:03:55.496 align:middle The consequence of this has really been some over these folks lending less to areas 00:03:55.496 --> 00:04:00.186 align:middle of the economy that, again, as we've said, have been getting loans for decades 00:04:00.186 --> 00:04:04.496 align:middle and the unique part of this era of this transition, or maybe evolution 00:04:04.496 --> 00:04:08.086 align:middle of the banking system, is that a lot of the high quality assets that sat 00:04:08.086 --> 00:04:11.096 align:middle on these bank balance sheets, and again, particularly in regional banks, 00:04:11.176 --> 00:04:12.506 align:middle has now started to come to market. 00:04:12.506 --> 00:04:17.156 align:middle So there is a clear financing need where the economy continues to grow, 00:04:17.426 --> 00:04:22.886 align:middle the balance sheets available from banks to fund this economic growth have shrunk, 00:04:22.886 --> 00:04:28.496 align:middle and the gap is getting filled both by private credit, but also by securitization, 00:04:28.496 --> 00:04:33.826 align:middle as we saw last year, record issuance across sectors like ABS and CLOs, 00:04:33.826 --> 00:04:36.896 align:middle as the market was looking for places to fund itself. 00:04:36.896 --> 00:04:40.636 align:middle At the same time, as yields increased, the opportunity set 00:04:40.636 --> 00:04:42.596 align:middle in fixed income is super attractive, right? 00:04:42.596 --> 00:04:47.936 align:middle So we're seeing a shift from insurance [inaudible], corporates, 00:04:47.936 --> 00:04:49.976 align:middle and even retail, into fixed income. 00:04:50.116 --> 00:04:52.706 align:middle Traditionally when you think about investing in fixed income, 00:04:52.766 --> 00:04:55.776 align:middle it means you're buying either sovereign or corporate credit risk. 00:04:55.886 --> 00:04:59.426 align:middle So as we've seen more investors come into fixed income markets, 00:04:59.456 --> 00:05:03.756 align:middle we've also seen investors have a need, or have a strong desire 00:05:03.756 --> 00:05:10.256 align:middle to diversify either existing exposures or increasing exposures across fixed income and ABF 00:05:10.256 --> 00:05:11.976 align:middle or securitized is really where we're seeing that happen. 00:05:13.086 --> 00:05:16.326 align:middle Why are pensions and insurance folks more active? 00:05:16.376 --> 00:05:18.896 align:middle Again, it's a confluence of things happening all at once. 00:05:19.126 --> 00:05:24.376 align:middle Yields aside, if we think about U.S. pensions, folks that weren't funded were 00:05:24.376 --> 00:05:27.276 align:middle in riskier securities with stocks at all-time highs, 00:05:27.276 --> 00:05:32.716 align:middle and high yield risks nearing all-time tights, it means the asset portfolio has increased. 00:05:32.716 --> 00:05:38.176 align:middle At the same time, due to higher yields, the discount rate for the liabilities has increased, 00:05:38.176 --> 00:05:40.526 align:middle meaning that a fund of ratios look a lot better. 00:05:40.746 --> 00:05:44.556 align:middle Putting all that together, it means that insurance folks who have been pretty active 00:05:44.556 --> 00:05:49.406 align:middle in pension risk transfers, so meaning the pension plan can now transfer its liability 00:05:49.406 --> 00:05:52.246 align:middle to another party, or, pensions that don't want to do that, 00:05:52.246 --> 00:05:54.256 align:middle and they're looking to de-risk themselves. 00:05:54.286 --> 00:05:59.636 align:middle Once you're at or over funded, you don't need to take on the risks you once took, 00:05:59.636 --> 00:06:03.156 align:middle and folks are looking to move into fixed income to call it, lock that I. 00:06:03.156 --> 00:06:07.906 align:middle So as we see, these large pools of capital move into fixed income markets, 00:06:07.906 --> 00:06:13.226 align:middle we're seeing a real need for diversification, high quality spreads, and candidly the ability 00:06:13.226 --> 00:06:16.926 align:middle to actually get invested, which we definitely have on the public side, 00:06:16.926 --> 00:06:20.256 align:middle but the private markets offer pretty unique ability to do that as well. 00:06:20.256 --> 00:06:24.006 align:middle >> That's a perfect transition to exploring some of the capabilities 00:06:24.006 --> 00:06:28.216 align:middle that are core to a successful ABF platform. 00:06:28.356 --> 00:06:33.046 align:middle When you talk about an asset class that kind of experienced this level of growth 00:06:33.046 --> 00:06:38.986 align:middle and attention just very naturally there are a lot of new participants and new entrants. 00:06:38.986 --> 00:06:43.716 align:middle I find us to be a bit unique in that respect in that we're not an opportunistic investor, 00:06:43.716 --> 00:06:47.616 align:middle and have actually been investing on behalf of the insurance companies for decades, 00:06:47.616 --> 00:06:52.666 align:middle structured products has been a cornerstone of our organization in fixed income. 00:06:52.956 --> 00:06:58.826 align:middle As you think about changes and evolutions in ABF and structured products, 00:06:58.826 --> 00:07:03.396 align:middle how do you think about the capabilities that are truly core to an ABF platform 00:07:03.396 --> 00:07:06.466 align:middle and differentiate an ABF platform? 00:07:06.466 --> 00:07:09.486 align:middle >> I think there's a handful of things investors need to keep in mind, 00:07:09.486 --> 00:07:12.456 align:middle and I would say there's more than one approach that works. 00:07:12.486 --> 00:07:14.866 align:middle But there is definitely not a lot of room in terms 00:07:14.866 --> 00:07:17.046 align:middle of the core building blocks you need to make it work. 00:07:17.046 --> 00:07:20.806 align:middle So, and what I mean by that core building blocks, once you enter private markets, 00:07:20.806 --> 00:07:22.436 align:middle it's really important to have scale, right? 00:07:22.436 --> 00:07:28.276 align:middle So as we were thinking about how to best deliver this market opportunity to our clients, 00:07:28.276 --> 00:07:32.006 align:middle being able to lean in on relationships that we have 00:07:32.006 --> 00:07:38.026 align:middle from the existing $130 billion dollar securitized products team, was really critical 00:07:38.026 --> 00:07:39.956 align:middle to our ability to source and originate these assets. 00:07:40.246 --> 00:07:42.756 align:middle So scale is really, really important in this market. 00:07:42.926 --> 00:07:47.206 align:middle The other thing that I'd say is equally, if maybe not more important, is research. 00:07:47.296 --> 00:07:51.526 align:middle We're very bottom-up focused, I do like to nuance that in addition 00:07:51.526 --> 00:07:55.746 align:middle to understanding the companies and the investments that we're making, 00:07:55.816 --> 00:07:59.756 align:middle it's also critical for securitized folks to understand the structures 00:07:59.816 --> 00:08:04.556 align:middle because while we can forecast how cash flows may work, ultimately the structure is going 00:08:04.556 --> 00:08:07.206 align:middle to dictate how different investors get paid. 00:08:07.306 --> 00:08:11.336 align:middle It's really critical to understand regulatory risks over time. 00:08:11.336 --> 00:08:15.416 align:middle Especially when some of these assets are touching things like mortgages or consumers. 00:08:15.416 --> 00:08:21.126 align:middle For you to really dig deep in both the asset valuation, the structure, and the documentation 00:08:21.126 --> 00:08:24.536 align:middle and covenants, and regulatory risks, you need large teams. 00:08:24.536 --> 00:08:26.056 align:middle Folks that specialize. 00:08:26.266 --> 00:08:30.356 align:middle Now the other bit of securitized product that's quite important is the ability 00:08:30.356 --> 00:08:32.096 align:middle to think through modeling. 00:08:32.096 --> 00:08:35.076 align:middle So there is quite a quantitative aspect to what we do. 00:08:35.076 --> 00:08:39.266 align:middle So pulling all that together, you need scale, you need depth of resources, 00:08:39.266 --> 00:08:41.976 align:middle and you need really technology and quantitative methods. 00:08:42.676 --> 00:08:46.436 align:middle >> The importance of research always resonates with me, it's near and dear to my heart. 00:08:46.806 --> 00:08:51.516 align:middle When I think about a lot of growth and new entrants into the market, 00:08:51.836 --> 00:08:55.486 align:middle I wonder if you're worried about the attractiveness 00:08:55.486 --> 00:08:57.986 align:middle of the opportunity set changing going forward. 00:08:57.986 --> 00:09:01.606 align:middle >> It's something we always wrestle with I suppose, and really any market. 00:09:01.606 --> 00:09:05.676 align:middle I would frame it this way, you always have, call it two different risks, right? 00:09:05.676 --> 00:09:10.826 align:middle One is either spreads compress because there is more demand than supply. 00:09:11.186 --> 00:09:14.346 align:middle But then separately could mean that the financing terms 00:09:14.346 --> 00:09:16.246 align:middle that you get are going to be worse. 00:09:16.246 --> 00:09:20.996 align:middle Right? So, it's possible spreads stay similar, but now the assets 00:09:20.996 --> 00:09:24.486 align:middle that you're financing are either of lower quality or the covenants 00:09:24.486 --> 00:09:26.266 align:middle that you get are less protective. 00:09:26.266 --> 00:09:30.026 align:middle So far what we're seeing is neither of those things come to fruition. 00:09:30.026 --> 00:09:32.876 align:middle We've seen a little bit of spread compression, but that's just the broader market. 00:09:32.876 --> 00:09:37.096 align:middle If we want to just frame the discussion around what we normally think 00:09:37.096 --> 00:09:41.566 align:middle of as private credit being corporate and high yield, that market is estimated 00:09:41.566 --> 00:09:43.306 align:middle to be about a trillion and a half. 00:09:43.306 --> 00:09:48.596 align:middle The estimate of ABF are anywhere from $5-$50 trillion. 00:09:48.636 --> 00:09:50.836 align:middle Just picking 15 because it's an easy number. 00:09:50.836 --> 00:09:54.476 align:middle You're talking about a market that if you compare it relative to corporate credit is 00:09:54.476 --> 00:09:59.796 align:middle at least 10 times the size, and while it has definitely been an area of focus for many folks, 00:09:59.796 --> 00:10:04.416 align:middle I think it's really because there is an opportunity, it's a large market, 00:10:04.416 --> 00:10:09.326 align:middle and spreads continue to remain pretty attractive and our ability and discipline 00:10:09.326 --> 00:10:12.906 align:middle to anchor bilateral investments remains pretty strong. 00:10:12.906 --> 00:10:16.466 align:middle So, lots of new folks for sure but we're still seeing really great pipeline. 00:10:17.056 --> 00:10:20.636 align:middle >> Relatedly, in thinking about core capabilities, 00:10:20.636 --> 00:10:23.836 align:middle how do you balance sourcing and underwriting? 00:10:23.836 --> 00:10:28.626 align:middle >> So, the way we've set up the team, and it's one business, Gabe Rivera, myself, 00:10:28.626 --> 00:10:29.976 align:middle have the pleasure of co-leading it. 00:10:29.976 --> 00:10:37.586 align:middle We have one research team and the way that we invest is we'll have portfolio managers 00:10:37.586 --> 00:10:40.706 align:middle or an ABF specifically will have folks that are more focused 00:10:40.706 --> 00:10:42.896 align:middle on the origination and issuer development. 00:10:42.896 --> 00:10:47.126 align:middle We'll have folks bring us opportunities, once we do a preliminary screen 00:10:47.126 --> 00:10:50.356 align:middle of what the opportunity is and making sure that it's thematic in terms 00:10:50.356 --> 00:10:53.346 align:middle of what we think makes sense as investments more broadly, 00:10:53.346 --> 00:10:56.446 align:middle that investment opportunity gets kicked over to our research team. 00:10:56.626 --> 00:10:59.376 align:middle The research process is independent, the research team, 00:10:59.376 --> 00:11:04.786 align:middle similar to our corporate credit teams, do not report into portfolio managers or originators, 00:11:04.786 --> 00:11:10.116 align:middle and we think this segregation of duty is really, really important for us to arrive 00:11:10.116 --> 00:11:15.866 align:middle at an estimation of risk that is independent of the pressures that originators 00:11:15.866 --> 00:11:18.046 align:middle or portfolio managers might have to get invested. 00:11:18.046 --> 00:11:24.326 align:middle So the way we balance the need to originate and maybe the need to invest relative to credit 00:11:24.326 --> 00:11:27.306 align:middle and risk, is really by having independence in the process. 00:11:27.306 --> 00:11:31.576 align:middle Now it all comes together, we all will huddle and talk about the pros and cons 00:11:31.576 --> 00:11:36.226 align:middle and our research team is really responsible for digging deep on these issuers, 00:11:36.366 --> 00:11:42.416 align:middle understanding the risks, thinking about the valuation of this asset, valuing the volatility 00:11:42.416 --> 00:11:46.186 align:middle of that asset over time, what are the value drivers, and ultimately they come 00:11:46.186 --> 00:11:50.576 align:middle to an internal rating and an ESG score to help us quantify those risks. 00:11:50.576 --> 00:11:54.856 align:middle So ultimately the credit team assesses the risk, and where the portfolio management team 00:11:54.856 --> 00:12:00.466 align:middle and effectively origination team, in concert, work on thinking about how to price that risk 00:12:00.466 --> 00:12:02.506 align:middle and then ultimately how to construct portfolios. 00:12:02.556 --> 00:12:04.776 align:middle So we think an independent process is really important. 00:12:04.776 --> 00:12:06.266 align:middle And we think it leads to better outcomes. 00:12:07.416 --> 00:12:11.616 align:middle >> One thing you talked about was there's a number of different styles 00:12:11.616 --> 00:12:13.806 align:middle and approaches in the marketplace. 00:12:14.026 --> 00:12:20.126 align:middle We've made a very specific and deliberate choice around not owning a captive originator 00:12:20.246 --> 00:12:25.926 align:middle and whenever we talk about the rationale that underscores that very deliberate decision, 00:12:25.926 --> 00:12:28.256 align:middle I always find it to be really interesting conversation. 00:12:28.256 --> 00:12:33.646 align:middle So would love to get your perspectives on why we've decided to move forward 00:12:33.646 --> 00:12:34.466 align:middle without a [inaudible] originator. 00:12:34.466 --> 00:12:38.506 align:middle >> So, there's different ways of originating private collateral. 00:12:38.506 --> 00:12:42.556 align:middle It's usually been more the private equity folks will have originators 00:12:42.556 --> 00:12:44.726 align:middle that are helping them find investments. 00:12:44.726 --> 00:12:49.306 align:middle We have purposely not chosen to own an origination platform largely 00:12:49.306 --> 00:12:51.686 align:middle because it does create conflicts of interest, right? 00:12:51.686 --> 00:12:55.486 align:middle So if we think about just first principles, if we own the originator, 00:12:55.486 --> 00:13:01.996 align:middle we own the equity in this company, and now I am asking our clients to buy the debt 00:13:01.996 --> 00:13:06.726 align:middle from these companies so there is a clear conflict in terms of how you price that debt, 00:13:06.726 --> 00:13:08.976 align:middle and how attractive that debt is relative to the broader market. 00:13:09.046 --> 00:13:15.666 align:middle We think our approach of not being captive to specific origination, whether it's good value 00:13:15.666 --> 00:13:19.196 align:middle or not, helps us deliver better relative value over time. 00:13:19.406 --> 00:13:24.456 align:middle I don't think that shuts a door completely on having an origination partner, 00:13:24.456 --> 00:13:29.586 align:middle or even origination business at some point in the future, I think there is a strategic reason 00:13:29.586 --> 00:13:34.706 align:middle to own them, particularly if the market is not giving you those opportunities otherwise. 00:13:34.766 --> 00:13:39.066 align:middle But again, I go back to, in a market that is trillions in size, 00:13:39.186 --> 00:13:43.476 align:middle candidly I think there's more supply of opportunities than we've seen demand, 00:13:43.476 --> 00:13:45.676 align:middle notwithstanding how strong the demand has been. 00:13:45.676 --> 00:13:48.856 align:middle So until I think we see the market continue to evolve, 00:13:48.856 --> 00:13:53.616 align:middle or transition into a more invested market, we're focusing on just the best relative value, 00:13:53.616 --> 00:13:55.346 align:middle and eliminating as many conflicts as we can. 00:13:55.346 --> 00:14:01.426 align:middle >> ABF is so broad-based, maybe start with a basic portfolio and talk 00:14:01.426 --> 00:14:07.126 align:middle through the implications of adding diversification and then adding additional risk. 00:14:07.126 --> 00:14:10.586 align:middle It's almost similar to securitized products at large. 00:14:10.746 --> 00:14:13.466 align:middle It really depends on what the goals of the clients are. 00:14:13.576 --> 00:14:18.496 align:middle So, I'd say honing in on say insurance as they're fairly active, 00:14:18.496 --> 00:14:25.016 align:middle most of the time what we're seeing is insurers are looking to ABF mostly in investment grade. 00:14:25.136 --> 00:14:30.576 align:middle They're looking at it as a great alternative or diversifier to existing investment grade debt. 00:14:30.576 --> 00:14:34.086 align:middle So, back to the idea that a lot of these portfolios are corporate credit driven. 00:14:34.256 --> 00:14:36.886 align:middle And it makes a lot of sense in terms of the ability 00:14:36.886 --> 00:14:39.826 align:middle to both source these assets and the spreads that we can get. 00:14:40.006 --> 00:14:45.576 align:middle Other investors will use ABF as a replacement for higher yielding investments. 00:14:45.576 --> 00:14:51.236 align:middle So, within ABF, again, similar to just broader securitized products, there's situations 00:14:51.236 --> 00:14:57.236 align:middle where we might be buying a pool of whole loans, and then one investor might find the pool 00:14:57.236 --> 00:15:00.366 align:middle of whole loans attractive, and we might think that the risk 00:15:00.366 --> 00:15:03.976 align:middle of these loans is investment grade, so that would be suitable for an investment grade buyer. 00:15:04.046 --> 00:15:09.776 align:middle At the same time, that pool of whole loans can be financed, whether that's through a bank 00:15:09.776 --> 00:15:17.036 align:middle or securitization, and an investor seeking to earn higher yields or displace, 00:15:17.036 --> 00:15:22.196 align:middle or simply diversify an existing private credit allocation in high yields, 00:15:22.196 --> 00:15:25.416 align:middle or even private equity candidly, the investor can focus 00:15:25.416 --> 00:15:27.536 align:middle on just the bottom portion of that securitization. 00:15:27.536 --> 00:15:31.106 align:middle Again, first principles, it's the same analysis, you're still underwriting the pool 00:15:31.106 --> 00:15:33.546 align:middle with collateral, the question is really, do you own the whole pool? 00:15:33.686 --> 00:15:37.146 align:middle Or do you just own a bottom portion of that exposure? 00:15:37.146 --> 00:15:39.796 align:middle So we're seeing investors really focus on both. 00:15:40.266 --> 00:15:45.486 align:middle There are other opportunities, and again, I think this comes more into the realm 00:15:45.486 --> 00:15:50.276 align:middle of owning an origination platform, but there are other parts of ABF 00:15:50.276 --> 00:15:53.066 align:middle where you can see double digit type returns, 00:15:53.066 --> 00:15:57.506 align:middle in which case truly offsetting much riskier allocations beyond high yield. 00:15:57.506 --> 00:16:00.036 align:middle And there I think the opportunity set is interesting, 00:16:00.036 --> 00:16:02.426 align:middle but the depth is definitely not as large. 00:16:02.426 --> 00:16:08.626 align:middle >> Sector [inaudible] runs again with some high quality very liquid sectors like AAA and CLOs, 00:16:08.626 --> 00:16:13.596 align:middle all the way through to private [inaudible], and [inaudible] riskier sectors. 00:16:13.596 --> 00:16:22.036 align:middle If I remove the constraints and I want to really optimize the ABF opportunity set that public, 00:16:22.036 --> 00:16:28.066 align:middle private, liquid, less liquid, how are you thinking about [inaudible] sectors and perhaps, 00:16:28.066 --> 00:16:31.006 align:middle or interestingly, sub-sectors today across ABF? 00:16:31.006 --> 00:16:35.546 align:middle You either wouldn't invest, or would remain quite skeptical of. 00:16:35.546 --> 00:16:37.886 align:middle >> Generally speaking, if we're just kind of doing a bit 00:16:37.886 --> 00:16:39.896 align:middle of a, call it a return bridge, right? 00:16:39.896 --> 00:16:41.996 align:middle So how do you start like building blocks. 00:16:41.996 --> 00:16:49.366 align:middle So, if we think of a traditional public securitized mandate that is of higher quality, 00:16:49.366 --> 00:16:55.256 align:middle we'll maybe deliver call it anywhere between 75 and 100 basis points, through a cycle, 00:16:55.256 --> 00:16:57.626 align:middle above investment grade corporates. 00:16:57.626 --> 00:17:00.706 align:middle And I'd say that's generically speaking, what we've observed and something 00:17:00.706 --> 00:17:04.626 align:middle like that is AAA CLOs, I think in today's environment if you're looking 00:17:04.626 --> 00:17:08.066 align:middle at where spreads are, you're looking at kind of your tail risks, 00:17:08.066 --> 00:17:11.096 align:middle I think AAA CLOs are a great investment for folks looking 00:17:11.096 --> 00:17:13.346 align:middle to augment those parts of those portfolios. 00:17:13.346 --> 00:17:17.276 align:middle Now, if you are more open to less liquid investments, 00:17:17.276 --> 00:17:19.566 align:middle the question is, okay, so what else do I get? 00:17:19.566 --> 00:17:22.606 align:middle And the answer is, we think you pick up another 75 00:17:22.606 --> 00:17:25.976 align:middle or 100 basis points beyond what you get in public securitizations. 00:17:26.046 --> 00:17:30.276 align:middle So, adding those two numbers up, we think you're getting somewhere between 150 00:17:30.276 --> 00:17:36.276 align:middle and 200 in investment grade ABF above what you would achieve in investment grade corporates. 00:17:36.276 --> 00:17:40.556 align:middle Right? So it's a very meaningful pickup, we do think you're getting what I'd say, 00:17:40.556 --> 00:17:43.776 align:middle quote-unquote, paid for, not having as much liquidity. 00:17:43.916 --> 00:17:49.186 align:middle The interesting thing about ABF is that unlike corporate credit where, again, 00:17:49.186 --> 00:17:53.116 align:middle a traditional capital structure has make it up a five-year maturity, 00:17:53.186 --> 00:17:56.306 align:middle you pay interest every six months, and then into the 60th month, 00:17:56.306 --> 00:17:58.786 align:middle or the fifth year, you have a principle repayment. 00:17:58.786 --> 00:18:03.076 align:middle If you have a five-year car loan, every month you're paying principle and interest, 00:18:03.076 --> 00:18:05.786 align:middle so the structure of the cash flows is actually quite different. 00:18:05.826 --> 00:18:11.466 align:middle So while it is private, and there is really little to no active trading, 00:18:11.536 --> 00:18:14.556 align:middle there is natural liquidity coming off the pools. 00:18:14.606 --> 00:18:17.496 align:middle Because we're receiving principle and interest monthly. 00:18:17.496 --> 00:18:19.386 align:middle So I think it's a pretty important future. 00:18:19.506 --> 00:18:26.536 align:middle The other piece I would say is on top of the spread pickup, again, 75 or 100 over securitized 00:18:26.536 --> 00:18:31.286 align:middle and 150 to 200 over investment grade, is today as a private lender, 00:18:31.396 --> 00:18:36.606 align:middle we're also able to achieve really attractive debt covenants in our deals, right? 00:18:36.606 --> 00:18:38.996 align:middle So it's not just spread, and I mentioned earlier, 00:18:38.996 --> 00:18:42.246 align:middle the folks coming in always either push spreads or terms. 00:18:42.246 --> 00:18:47.366 align:middle We're still achieving really attractive terms, and really what I'm talking about is in events 00:18:47.366 --> 00:18:53.356 align:middle of unexpected economic outcomes, there are ways of creating loss mitigating triggers 00:18:53.506 --> 00:18:58.816 align:middle where we can capture some extra protection that you structure into a private deal, 00:18:59.006 --> 00:19:01.406 align:middle that you would not see in a public securitization. 00:19:01.406 --> 00:19:03.956 align:middle So, I'd say it's spread and terms, yet again. 00:19:03.956 --> 00:19:08.656 align:middle >> It's a good prompt for something that I think I always try to make sense of, 00:19:08.656 --> 00:19:14.436 align:middle and I'm sure you could ask quite frequently, is it an indexed strategy or an absolute strategy? 00:19:14.646 --> 00:19:22.676 align:middle And relatedly, how do I compare manager experience given the very unique nature 00:19:22.676 --> 00:19:25.526 align:middle of some of these portfolio's vehicles? 00:19:26.146 --> 00:19:27.596 align:middle >> The short answer is it's tough. 00:19:27.596 --> 00:19:31.816 align:middle So I think on the investment grade side, many folks will think about this 00:19:31.816 --> 00:19:36.936 align:middle as a solution largely, not solely, but largely in the intermediate part of the curve. 00:19:36.936 --> 00:19:38.876 align:middle So call it three to five years, right? 00:19:38.876 --> 00:19:42.166 align:middle We just talked about auto loans, that's naturally a five-year asset, 00:19:42.166 --> 00:19:44.466 align:middle so the assets that we're seeing are generally short. 00:19:44.466 --> 00:19:49.386 align:middle That kind of goes hand in hand candidly with the ideas that the banking system is financing less 00:19:49.386 --> 00:19:52.506 align:middle of this, the banking system generally doesn't make 30-year loans. 00:19:52.506 --> 00:19:55.016 align:middle So it's generally short or intermediate direction. 00:19:55.016 --> 00:19:58.986 align:middle So many folks look at, call it something like a three to five year corporate index as a proxy 00:19:58.986 --> 00:20:02.106 align:middle for just trying to think about what the returns should look like. 00:20:02.106 --> 00:20:04.976 align:middle Now it's important to remember, these are private markets, 00:20:05.026 --> 00:20:10.606 align:middle so the way that many folks think of it is really in the context of acquisition spreads. 00:20:10.606 --> 00:20:16.436 align:middle So, if I can originate an ABF opportunity, how much more am I getting paid above 00:20:16.436 --> 00:20:20.976 align:middle and beyond what this short intermediate corporate index is affording investors today? 00:20:21.086 --> 00:20:26.086 align:middle The public credit markets are going to move up and down, so I think it's one of these things 00:20:26.086 --> 00:20:28.236 align:middle where the private markets are not going to behave that way. 00:20:28.236 --> 00:20:31.576 align:middle So you do have to look at it through a longer time horizon. 00:20:31.576 --> 00:20:36.896 align:middle Similar in high yield, we see folks think about it as what is the comparable return I'd earn 00:20:36.896 --> 00:20:41.506 align:middle on a bank loan portfolio or even a private credit, direct lending portfolio, 00:20:41.506 --> 00:20:45.696 align:middle and generally there we've see at least is folks are really thinking about this over cash, 00:20:45.776 --> 00:20:50.686 align:middle so if longer term public bank loans are somewhere around three to 350, 00:20:50.686 --> 00:20:56.876 align:middle and private credit picks up another 200-ish on core middle market, or upper middle market, 00:20:56.876 --> 00:21:03.146 align:middle you're around 550, 600, maybe even 650 if you go into smaller companies on private credit. 00:21:03.316 --> 00:21:05.916 align:middle The high yield ABF mandates are generally looking 00:21:05.916 --> 00:21:08.376 align:middle to target somewhere around four to 600 as well. 00:21:08.506 --> 00:21:11.696 align:middle So again, it's all kind of based on cash as you go down the capital structure. 00:21:12.906 --> 00:21:18.146 align:middle >> You talked about some of the ABF sectors as being shorter, intermediate in nature, 00:21:18.146 --> 00:21:21.956 align:middle I would add that many of those sectors finance themselves at the shorter end 00:21:21.956 --> 00:21:23.776 align:middle of the curve, but floating rates. 00:21:24.306 --> 00:21:29.606 align:middle That obviously requires frequent rebalancing, more frequent asset replacement, 00:21:29.696 --> 00:21:32.526 align:middle which leaves me curious, or created some uncertainty 00:21:32.526 --> 00:21:35.386 align:middle around the ex ante return experience. 00:21:35.386 --> 00:21:38.016 align:middle How do you think through that to manage your investor? 00:21:38.086 --> 00:21:42.676 align:middle >> I think again it goes back to what's the benchmark, what are folks expecting? 00:21:43.176 --> 00:21:47.756 align:middle I would say some of the short assets, although it is short, Brian, just kind of sticking 00:21:47.756 --> 00:21:50.866 align:middle with that same example we had, like not all loans are going to be fixed rate, 00:21:50.866 --> 00:21:53.326 align:middle so although it's maybe two or three years on average, 00:21:53.356 --> 00:21:55.076 align:middle you're really looking at fixed rate cash flows. 00:21:55.076 --> 00:21:59.056 align:middle But to answer your question, and I think it's one of the things where we think a lot 00:21:59.056 --> 00:22:05.386 align:middle about as we're doing the origination, we look to give ourselves some degree of certainty 00:22:05.386 --> 00:22:11.156 align:middle on those spreads, or those cash flows, vis-a-vis call protection, or make calls to the extent 00:22:11.156 --> 00:22:12.546 align:middle that there's a refinancing option. 00:22:12.546 --> 00:22:16.396 align:middle But generally again, we're really thinking a lot about the embedded options, 00:22:16.396 --> 00:22:20.996 align:middle ex ante we've seen returns, the key part here is, if you're looking at it 00:22:20.996 --> 00:22:24.616 align:middle over a comparable public investment grade corporate, you're really trying to think 00:22:24.616 --> 00:22:29.086 align:middle about okay, what's the tenor of each investment, and assuming both pay you back, 00:22:29.086 --> 00:22:31.056 align:middle did I earn my spread over that period of time? 00:22:31.056 --> 00:22:34.186 align:middle And that's going to come from two factors, as you suggest, one is credit, 00:22:34.186 --> 00:22:37.556 align:middle which again we feel really comfortable with, and the other one is some embedded optionality, 00:22:37.596 --> 00:22:39.726 align:middle which again, we're trying to minimize through the structure. 00:22:40.666 --> 00:22:45.376 align:middle >> We've talked a lot about growth in the asset class, broadening of market participants, 00:22:45.576 --> 00:22:49.526 align:middle but it's also true that we've been in quite a [inaudible] economic environment, 00:22:49.526 --> 00:22:54.986 align:middle consumer has been pretty good shape overall, [inaudible] obviously the lower end consumer, 00:22:54.986 --> 00:22:59.436 align:middle but holistically it's been a really good backdrop for credit generally. 00:22:59.596 --> 00:23:04.786 align:middle One of the pushbacks around ABS is well, the asset class is 00:23:04.786 --> 00:23:06.736 align:middle so new it's never really been tested. 00:23:06.736 --> 00:23:10.976 align:middle Edwin, what's your perspective on the asset class having not been tested? 00:23:10.976 --> 00:23:15.346 align:middle >> Yeah, I would say in short, maybe going back to bellbottoms, this is an asset class 00:23:15.346 --> 00:23:17.066 align:middle that has really been around for a really long time. 00:23:17.066 --> 00:23:22.566 align:middle Funding the real economy has occurred through banks and securitization in the past, 00:23:22.566 --> 00:23:27.276 align:middle so things like auto loans, consumer loans, student loans are just examples of some assets 00:23:27.276 --> 00:23:29.556 align:middle that have resided in our markets for quite a bit. 00:23:29.556 --> 00:23:34.936 align:middle So I'd say, in short Brian, while the label is new, and the asset class itself is rich 00:23:34.936 --> 00:23:40.066 align:middle in history of data and our team has access to decades' worth of data around consumer, 00:23:40.066 --> 00:23:42.306 align:middle mortgages, and a lot of other asset classes. 00:23:42.306 --> 00:23:45.556 align:middle So, it feels really comfortable with our ability to underwrite through a cycle. 00:23:45.556 --> 00:23:49.506 align:middle As we have seen these cycles before and across a lot of these assets. 00:23:49.506 --> 00:23:54.716 align:middle >> Edwin, we've covered quite a bit of ground, maybe to conclude we'll go back to the future, 00:23:54.766 --> 00:23:58.306 align:middle and we spent a lot of time talking about evolutions in the asset class, 00:23:58.386 --> 00:24:02.696 align:middle the investor base, dispense, and just broad-based gross, 00:24:02.956 --> 00:24:04.796 align:middle when you look out over the next decade, 00:24:04.826 --> 00:24:07.706 align:middle what do you think the asset class is likely to look like? 00:24:08.866 --> 00:24:14.636 align:middle >> My sense is the asset class will continue to, for lack of better terms, grow. 00:24:14.696 --> 00:24:17.876 align:middle Although it's funny to say it's growing because we're already kind of saying it's 00:24:17.876 --> 00:24:20.996 align:middle in the trillions of dollars, but I would say it's just more widely adopted. 00:24:21.326 --> 00:24:26.986 align:middle It becomes part of the toolkit for investors to allocate I think similar to what we've seen 00:24:26.986 --> 00:24:31.246 align:middle in the last, call it decade or two in most all private credit, 00:24:31.246 --> 00:24:36.116 align:middle which is really corporate lending, be more part of fixed income allocations, I think ABF 00:24:36.116 --> 00:24:40.276 align:middle and candidly securitized overall will play a bigger part in portfolios 00:24:40.276 --> 00:24:43.496 align:middle as there are clear benefits around just not relative value, but diversification. 00:24:43.496 --> 00:24:49.066 align:middle So I think it's just continued implementation adoption in both public and private markets. 00:24:49.066 --> 00:24:50.366 align:middle >> And that's really well-said. 00:24:50.506 --> 00:24:53.746 align:middle Edwin, thank you so much for your thoughts and perspectives. 00:24:53.746 --> 00:24:58.906 align:middle If you are interested in learning more about ABFs or credit markets in transition, 00:24:58.966 --> 00:25:02.046 align:middle please check out our website, pgimfixedincome.com, 00:25:02.366 --> 00:25:05.266 align:middle for a series of videos, blogs, and white papers. 00:25:05.616 --> 00:25:08.396 align:middle Until next time, thanks for listening to All the Credit. 00:25:09.636 --> 00:25:11.026 align:middle >> We hope you enjoyed today's podcast. 00:25:11.626 --> 00:25:14.526 align:middle Subscribe to keep up with the latest episodes of All the Credit. 00:25:14.776 --> 00:25:18.436 align:middle For more insights and thought leadership, visit pgimfixedincome.com. 00:25:19.006 --> 00:25:21.516 align:middle This podcast is intended solely for professional investor use. 00:25:21.626 --> 00:25:24.006 align:middle Past performance is not a guarantee of future results. 00:25:24.266 --> 00:25:26.786 align:middle All investments involve risk, including the loss of capital. 00:25:27.146 --> 00:25:30.826 align:middle This material is not for distribution to any recipient located in any jurisdiction 00:25:30.826 --> 00:25:32.486 align:middle where such distribution is unlawful. 00:25:32.766 --> 00:25:34.996 align:middle This podcast includes the views and opinions of the authors 00:25:34.996 --> 00:25:37.046 align:middle and may not reflect PGIM Fixed Income's views. 00:25:37.486 --> 00:25:39.866 align:middle PGIM and its related entities may make investment decisions 00:25:39.926 --> 00:25:41.986 align:middle that are inconsistent with the views expressed herein. 00:25:42.266 --> 00:25:45.196 align:middle This podcast should not be reproduced without PGIM's prior written consent. 00:25:45.596 --> 00:25:49.586 align:middle No liability is accepted for any direct, indirect, or consequential laws that may arise 00:25:49.646 --> 00:25:52.926 align:middle from the use of any information contained in or derived from this podcast. 00:25:53.276 --> 00:25:55.446 align:middle PGIM Fixed Income is not acting as your fiduciary. 00:25:55.666 --> 00:25:59.246 align:middle The contents are for informational purposes only, are based on information available 00:25:59.246 --> 00:26:00.966 align:middle when created, and are subject to change. 00:26:01.186 --> 00:26:03.636 align:middle It is not intended as investment, legal, or tax advice, 00:26:03.716 --> 00:26:06.046 align:middle and does not consider a recipient's financial objectives. 00:26:06.496 --> 00:26:09.816 align:middle PGIM Fixed Income is a business unit of PGIM, the global asset management business 00:26:09.816 --> 00:26:13.456 align:middle of Prudential Financial Inc., which is not affiliated in any manner with Prudential PLC, 00:26:13.826 --> 00:26:16.976 align:middle incorporated in the United Kingdom, or with Prudential Assurance Company, 00:26:17.256 --> 00:26:20.376 align:middle a subsidiary of M&G plc incorporated in the United Kingdom. 00:26:20.626 --> 00:26:21.816 align:middle Copyright 2025. 00:26:22.026 --> 00:26:24.666 align:middle The PGIM logos and the rock symbol are service marks of PGIM 00:26:24.666 --> 00:26:27.766 align:middle and its related entities registered in many jurisdictions worldwide.