Borrowers face funding trade-off as PIMCO flags debt market cracks

PIMCO President Christian Stracke is upbeat on the asset-based finance segment of the private credit market, but warns of “cracks” in corporate direct lending, which makes up the bulk of the sector.

Speaking with CNBC at the annual Milken Asia Summit in Singapore Wednesday, Stracke highlighted the widening gap between the two lending spheres.

“There are problems [in corporate private credit] where borrowers are going to their lenders and saying, ‘Can I not pay you cash interest now, but basically borrow the interest from you and pay it later?’ It’s called Payment-in-Kind [PIK], and it’s fairly prevalent right now,” Stracke said.

He referred to asset-based financing as a “much healthier” credit environment.

“In asset-based financing — residential mortgages, consumer loans, student loans and auto loans — the economy is strong, households are strong, the consumer is strong, and we really aren’t seeing cracks that way,” he added.

The widening gap stems from the aftermath of the 2008 Global Financial Crisis, which saw consumer borrowers scale back their borrowing and deleverage their household balance sheets, which has helped boost asset-based financing activity. Corporate borrowers, in contrast, have built up their leverage and have “less clean” balance sheets.

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In October last year, PIMCO raised more than $2 billion for asset-based specialty financing strategy as part of its continued push into private credit.

Corporate borrowers also face a trade-off in public versus private debt markets, according to Stracke.

The smaller number of lenders in private markets means it can be easier for borrowers to renegotiate loan terms in the event of loan pressure — albeit with higher costs.

More liquid bank debt, on the other hand, comes at a much lower cost, though the refinancing process can be trickier.

“It’s more difficult with a broadly syndicated bank loan or bond,” Stracke said. “We’re seeing some real problem in the credit markets. There have been some high-profile defaults in the credit markets — in the public markets — where it’s very difficult for the company to negotiate with the lenders to preserve value in the company.”

Looking ahead, Stracke said that as the Federal Reserve continues on its path of interest rate cuts, and the overall all-in cost of borrowing comes down, particularly in mortgage rates, there will be more opportunities for PIMCO to take advantage of that demand for credit.

Meanwhile, David Elia, CEO of Australian superannuation fund Hostplus, said institutional investors in search of portfolio diversification are increasingly drawn to the private markets space – but said regulation should be focused on the retail wealth space.

Elia told CNBC at the Milken Asia summit that any push for tougher regulation of private markets should center around “mom-and-dad” investors who are attracted to the diversifying benefits of the asset class, rather than sophisticated institutional investors.

“There are probably about 19,000 companies that are listed on global markets. There are 140,000 private companies who generate in excess of $100 million in U.S. revenue,” Elia said.

“As long-term institutional investors, you will not see the level of concentration, if you’re genuine about diversification, in listed markets. Therefore, it’s going to drive you towards the unlisted sector, largely around private equity-style types of investments.”

He also predicted more IPOs in the coming months.